Index

Strategic partisan transfers in a fiscal federation: Evidence from a new Brazilian database (pp. 211-239)

This article makes use of a unique database that allows, for the first time, calculating in a precise way the amounts of discretionary transfers from the Brazilian Federal government to municipalities in the period from 1997 to 2012. The new database is used to test the “strategic partisan transfers hypothesis”, which states that mayors from the same party as the president receive higher federal transfers than those from different parties, if the corresponding municipality is situated in a state where the governor is not aligned with the president. In general, the econometric analysis strongly supports the strategic partisan transfers hypothesis. Furthermore, it supports the hypothesis that there is a biannual political transfers cycle in Brazil due to the country’s staggered electoral system with elections every other year.

Regional income redistribution and risk-sharing: Lessons from Argentina (pp. 241-269)

This paper estimates redistribution and risk-sharing across provinces in Argentina during the 1995-2010 period as a result of the national budget. We find that the aggregate national budget (expenditure, transfers and their corresponding revenues) reduces differences in the per capita provincial Gross Geographic Product by 5% in the long term, and stabilizes such differences by 10%. The redistributive tool is national expenditure, while automatic intergovernmental transfers are almost neutral and tax revenues amplify regional disparities. The quantitative effects are somewhat modest in comparison with those achieved in developed countries. Regressive taxation is the key difference with developed countries.

We develop a competitive general equilibrium model with heterogeneous firms and endogenous entry and exit to contrast the effects of coupled and decoupled subsidies. Unlike coupled subsidies, decoupled subsidies are not tied to a producer’s level of output, so they are thought to be less distortive. We challenge this view by proving that, in a model with endogenous TFP, coupled subsidies have no effect on TFP while decoupled subsidies have a negative effect. Moreover, our numerical experiments show that, for a given level of government expenditure, decoupled subsidies can lower welfare more than coupled subsidies.

Is there a Beveridge curve in the short and the long run? (pp. 283-303)

The theoretical Beveridge curve has a negative slope and is convex to the origin, a relationship most often associated to the short run. However, search and matching theory indicates that certain shocks may affect unemployment and vacancies in the same way. I trace the effects of both types of shocks affecting the vacancy rate and the unemployment rate using U.S. data. I impose common factor restrictions in an unobserved component model and sign restrictions in a vector autoregressive model. I derive negatively and positively-correlated components of vacancies and unemployment. The negatively-sloped Beveridge curve is the result of an aggregate labour demand shock. This shock also causes some more long-lasting effects for vacancies and unemployment, the ‘loops’ around the Beveridge curve. The shock that creates a positive co-movement between vacancies and unemployment is due to matching efficiency and job destruction. This positive co-movement occurs after recessions and in the long run.

The macroeconomic crisis of the last decade reopened questions about how economic agents define plans and expectations. The crisis triggered widespread, yet ongoing revisions of the beliefs entertained by agents and economists. The decision errors that result in crises do not necessarily derive from behavioral biases: often, those choices were rationalized with reference to established conventional wisdom, backed by economic theories influential at the respective times. Thus, understanding such socially relevant events requires addressing concretely how people build decision scenarios in changing environments, and how those interact with the evolution of prevalent economic analysis. A revision of Keynes’ work on uncertainty, especially his notion of “weight of evidence”, can help in this respect. In this paper we analyze some central informational elements of macro crises, discuss weaknesses of the standard analyses which try to accommodate critical phenomena into the rational expectations framework, and comment on ways to move ahead.

In this study we use survey expectations about a wide range of economic variables to forecast real activity. We propose an empirical approach to derive mathematical functional forms that link survey expectations to economic growth. Combining symbolic regression with genetic programming we generate two survey-based indicators: a perceptions index, using agents’ assessments about the present, and an expectations index with their expectations about the future. In order to find the optimal combination of both indexes that best replicates the evolution of economic activity in each country we use a portfolio management procedure known as index tracking. By means of a generalized reduced gradient algorithm we derive the relative weights of both indexes. In most economies, the survey-based predictions generated with the composite indicator outperform the benchmark model for one-quarter ahead forecasts, although these improvements are only significant in Austria, Belgium and Portugal.

Using data on Uruguayan firms (1997-2008) this paper explores whether the extent of informality in a sector affects a firm’s investment decision either directly or indirectly through a credit availability channel. The results suggest that financial restrictions affect investment decisions: a one percentage point increase in overall credit growth translates into a one half percentage point increase in investment rates. It is also found that, although there is no direct effect of informality on the firm investment decision, there is an indirect effect through the borrowing channel.

This paper re-examines the nexus between financial development and openness in developing countries. Specifically, we test whether both financial and trade openness explain financial development and its variations across 44 developing economies. Questioning the functional specifications in previous studies, we propose a fully nonparametric modelling approach to validate the simultaneous openness hypothesis. Our findings from the parametric approach suggest that both openness dimensions positively impact financial development, providing a loose support for the simultaneous openness hypothesis. The results based on the nonparametric approach suggest a negative effect of closed economies (economies with relatively closed trade and capital accounts) on financial development, supporting the strong version of the simultaneous openness hypothesis. Correct model specification test results support the nonparametric model relative to the parametric model as appropriate for the sampled data. Our conclusion is therefore based on the nonparametric finding, which supports the simultaneous openness hypothesis for the selected developing countries.

Ummad MazharLahore University of Management SciencesJuvaria JafriCity, University of London

Can the shadow economy undermine the effect of political stability on inflation? Empirical evidence (pp. 395-420)

This paper revisits the empirical relationship between political stability and inflation while explicitly accounting for the presence of the shadow economy. Using a large data set of 122 countries over the 1999 to 2007 period, we find that the well established negative correlation between political stability and inflation holds only if the size of the shadow economy remains modest; and it ceases to exist at higher levels of the size of the informal sector. This finding contributes to the existing literature on public finance that assigns special importance to political determinants of inflation. The results are robust against alternative specifications and satisfy the usual assumptions of a valid statistical inference.

Man vs. machine: An investigation of speeding ticket disparities based on gender and race (pp. 1-28)

This paper analyzes the extent to which police behavior in giving speeding tickets differs from the ticketing pattern of automated cameras, which provide an estimate of the population of speeders. The novel data are obtained from Lafayette, Louisiana court records, and provide specific details about the ticketed driver as well as a wide range of violation characteristics. In contrast to the automated cameras, the probability of a ticketed driver being female is consistently and significantly higher when the ticket was given by a police officer. For African-American drivers this effect is less robust, though in general still positive and significant. This implies that police use gender and race as a determining factor in issuing a speeding ticket. Potential behavioral reasons for this outcome are discussed. The validity of using automated cameras as a population measure for police-issued tickets is thoroughly investigated and supportive evidence is provided.

Triple penalty in employment access: The role of beauty, race, and sex (pp. 29-47)

This article reports the results from a first experiment specifically designed to disentangle the effect of beauty from that of race in the observed labor market discrimination, for both females and males in Peru. We randomly assigned Quechua and white surnames and (subjectively perceived) attractive or homely-looking photographs (or no photos) to 4,899 fictitious résumés sent in response to 1,247 job openings. We find that candidates who are physically attractive, have a white-sounding surname, and are males, receive 82%, 54%, and 34% more callbacks for job interviews than their similarly-qualified counterparts, thus imposing a triple penalty on homely-looking, indigenous, and female job candidates. We further find that the intensity of discrimination by race and physical appearance differs for males and females; the intensity of discrimination by physical appearance and sex differs for Quechua and white applicants; and the intensity of racial and sexual discrimination differs for beautiful and homely-looking persons.

Conventional views and asset prices: What to expect after times of extreme opinions (pp. 49-73)

This study evaluates the performance of stock market indices after times of extreme opinions. The underlying conjecture is that extreme opinions are associated to overreactions in the perception of wealth. The analysis covers 34 countries from 1988 through 2013. In a novel approach, views regarding economic performance are approximated using content in the global economic press. Consistent with the overreaction conjecture, stock market indices are shown to under-perform following extreme optimistic views and over-perform after pessimistic views. A long-short contrarian portfolio earns 11% annually over the next five years. This persistent and predictable difference in returns cannot be explained by risk considerations and cannot be replicated using alternative strategies based on past returns or past economic growth.

Determinants of inflation differentials in the euro area: Is the New Keynesian Phillips Curve enough? (pp. 75-103)

In the euro area, inflation rates diverged after the creation of the single currency, and started to converge again from mid-2002. It is against this background that the paper studies the determinants of inflation differentials in the euro area. We start by using the New Keynesian Phillips Curve (NKPC) to explain inflation differences for a panel of countries. Exchange rate movements and expected inflation in particular play an important part in bringing about diverging inflation dynamics, while lagged inflation does not. The Incomplete Competition Model (ICM) adds explanatory power to the NKPC in describing inflation dynamics across countries. The latter model does not encompass ICM, and the variables proposed by the ICM are statistically significant: the growth in nominal Unit Labour Cost and the long-run disequilibrium between prices and costs explain inflation differentials.

Mehmet BalcilarEastern Mediterranean University, University of Pretoria and Montpellier Business SchoolRangan GuptaUniversity of Pretoria and IPAG Business SchoolCharl JoosteUniversity of Pretoria

The growth-inflation nexus for the U.S. from 1801 to 2013: A semiparametric approach (pp. 105-120)

We study the existence of a threshold level of inflation for the U.S. economy over 1801- 2013, beyond which it has a negative effect on economic growth. A combination of nonparametric (NP) and instrumental variable semiparametric (SNP-IV) methods obtain inflation thresholds for the United States. The results suggest that the relationship between growth and inflation is hump shaped –that higher levels of inflation reduce growth more compared to low inflation or deflation. The strongest result to emerge from the study consistently shows that inflation above two per cent negatively affects growth. Two additional parametric methods confirm this finding. Another important result is that high or very low levels of inflation are undesirable and are associated with lower growth - hinting that a growth maximizing value of inflation exists.

Faqin LinCentral University of Finance and Economics (CUFE)Dongzhou MeiCentral University of Finance and Economics (CUFE)Huanhuan WangEast China Normal UniversityXi YaoPeking University

Romer was right on openness and inflation: Evidence from Sub-Saharan Africa (pp. 121-140)

Romer (1993) documents a negative relation between trade openness and inflation and offers an explanation based on time-inconsistency of monetary policy, but subsequent research casts doubt on the negative relationship and the explanation. This paper contributes to this debate by estimating the effect of openness to international trade on inflation with panel data from Sub-Saharan Africa. Employing instrumental variable techniques that correct for endogeneity bias of trade openness, the empirical evidence suggests that within-country variations in trade openness restrict inflation: a 1 percentage point increase in the ratio of trade over gross domestic product is associated with a decrease in inflation of approximately 0.08 percentage points per year. These results are robust to additional controls, different measurements of trade openness and alternative instruments. Finally, we inspect the timeinconsistency mechanism of the negative-relationship between trade openness and inflation.

Is gerontocracy harmful for growth? A comparative study of seven European countries (pp. 141-168)

We study the relationship between gerontocracy and aggregate economic performance in a simple model where growth is driven by human capital accumulation and productive government spending. We show that less patient élites display the tendency to underinvest in public education and productive government services, and thus are harmful for growth. The damage caused by gerontocracy is mainly due to the lack of long-term delayed return on investments, originated by the lower subjective discount factor. An empirical analysis using public investment in Information and Communication Technologies (ICT) is carried out to test theoretical predictions across different countries and different economic sectors. The econometric results confirm our main hypotheses.

Logistics and transport increasingly play a pivotal role in international trade relations. The Logistics Performance Index (LPI) measures the on-the-ground efficiency of trade supply chains or logistics performance. The aim of this paper is to propose a data envelopment analysis (DEA) approach to compute a synthetic index of overall logistics performance (DEA-LPI) and benchmark the logistics performance of the countries with LPI. Dealing with the six dimensions of LPI, the proposed approach uses DEA as a tool for multiple criteria decision making (MCDM). Furthermore, the paper also analyses the potential differences observed when using different variables, namely income and geographical area. Our findings suggest that the logistics performance depends largely on income and geographical area. High income countries are in the group of best performers, which is highly dominated by the EU.

Imposing concavity and the null-jointness property on the production possibilities frontier in case of polluting technologies (pp. 193-210)

Economic theory requires the directional distance functions used to study the properties of production possibility sets of polluting technologies to be concave in both outputs, while the implied production possibilities frontier (PPF) is required to be concave with respect to the bad output. However, existing estimation frameworks do not preclude the estimation of convex PPFs. We analyze geometrical properties of the quadratic approximation to the directional output distance functions to derive a constraint that guarantees PPF concavity and consider the issue of imposing the property of null-jointness on the production possibilities set, which is also required by theory. We simulate a dataset corresponding to a concave PPF and show that in case concavity and null-jointness constraints are not imposed, it is possible that the conventional estimation framework may lead to erroneous conclusions with respect to the type of curvature of both the directional output distance function, and the PPF.

The relationship between macroeconomic performance and institutional change is explored in member countries of the Organization for Economic Cooperation and Development (OECD). We first assess the effects of national income growth, unemployment and inflation on subjective well-being (SWB) in thirty OECD countries, and employ the relationships found to construct an index of macroeconomic performance in terms of SWB. Applying the index to the period 1990-2009, we find that macroeconomic performance has improved in OECD overall and in the majority of countries, and that there has been a convergence of performance within the OECD. We then present evidence that OECD countries’ performance, as measured, is positively related to institutional change towards more trade openness and better institutional quality. We argue that both increased openness and improved institutional quality are correlates of economic and political integration and conclude that international integration has enhanced SWB by improving OECD countries’ national macroeconomic performance.

David W. GalensonUniversity of Chicago and Universidad del CEMASimone LenzuUniversity of Chicago

Pricing genius: The market evaluation of innovation (pp. 219-248)

Economists have neglected a key issue for understanding and increasing technological change, in failing to study how talented individuals produce innovations. This paper takes a quantitative approach to this problem. Regression analysis of auction data from 1965-2015 reveals that the age-price profiles of Jackson Pollock and Andy Warhol – the two greatest painters born in the 20th century – closely resemble the profiles of the two artists’ careers derived both from textbooks of art history and from retrospective exhibitions. The agreement of these sources confirms that the auction market assigns the highest prices to the art that scholars judge to be the most important, and examination of the artists’ careers reveals that this art is the most important because it is the most innovative. These results lend strong support to our understanding of creativity at the individual level, with a sharp contrast between the extended experimental innovation of Pollock and the sudden conceptual innovation of Warhol.

We compare Price-Level Targeting (PLT) versus Inflation Targeting (IT) using a New Keynesian model, which exhibits inflation persistence (as a result of partial indexation to lagged inflation). We find that, for standard values of the underlying parameters, (i) the loss associated to macroeconomic volatility may decrease about 29% by switching to PLT, (ii) a wide range of values for the weight given by the PLT central bank to output stabilisation allows to attain higher levels of social welfare, (iii) the higher the price rigidity the wider the range over which PLT outperforms IT, but the lower the welfare gain, and (iv) only when the level of indexation is higher than 65% it becomes better not to switch to PLT.

In this paper we empirically explore the impact of the presence of informal economies on long-run economic growth. Using a novel panel dataset of 161 countries over the period from 1950 to 2010 we obtain an inverted-U relationship between informal sector size and growth of GDP per capita. That is, small and large sizes of the informal economy are associated with little growth and medium levels of the size of the informal economy are associated with higher levels of growth. We also observe that in high (low) income economies, informal economy size is positively (negatively) correlated with growth. Moreover, when we decompose growth into several components using a simple growth accounting framework, we find that informality is mainly associated with growth in TFP and that this association is different in high and low-income economies.

Due to the recent financial crisis, the interest in econometric models that allow to incorporate binary variables (such as the occurrence of a crisis) experienced a huge surge. This paper evaluates the performance of the Qual VAR, originally proposed by Dueker (2005). The Qual VAR is a VAR model including a latent variable that governs the behavior of an observable binary variable. While we find that the Qual VAR performs reasonable well in forecasting (outperforming a probit benchmark), there are substantial identification problems even in a simple VAR specification. Typically, identification in economic applications is far more difficult than in our simple benchmark. Therefore, when the economic interpretation of the dynamic behavior of the latent variable and the chain of causality matter, use of the Qual VAR is inadvisable.

Banking instability and deposit insurance: The role of moral hazard (pp. 323-350)

The primary objective of this paper is to investigate the impact of moral hazard on the effectiveness of deposit insurance in achieving banking stability. If moral hazard explains banking instability arising from the adoption of deposit insurance, then deposit insurance will be associated with bank insolvency more than with bank runs. To test the hypothesis, we develop a new empirical framework distinguishing between banking instability initiated by panic withdrawals of deposits, and banking instability initiated by the insolvency problem of banks. Using a dataset covering 118 countries over the period 1980-2004, we find that deposit insurance per se has no significant effect either on bank insolvency or on bank runs. However, interacting deposit insurance with credit to the private sector, we observe a positive and significant effect on bank insolvency and bank runs, suggesting that moral hazard outweighs the positive effect of deposit insurance on banking stability.

The distribution of exchange rates under a minimum exchange rate regime (pp. 351-362)

This paper adjusts the Chen and Giovannini (1992) me t h o d o l o g y to estimate the unconditional distribution of exchange rates under a one-sided target zone regime, where a central bank commits itself to intervene on foreign exchange markets to prevent its currency to move beyond a previously announced target level vis-à-vis a specific foreign currency. An application of this methodology to the 2011–2015 EUR/CHF minimum exchange rate regime shows that the Swiss National Bank presumably intervened only at (or very close to) the floor level of EUR/CHF 1.20 and not at a level significantly above that boundary. Hence, contrary to previous studies, the reported results accord with the predictions of the Krugman (1991) target zone model about the behavior of exchange rates, allowing investors to gain insights about the central bank’s policy function in extraordinary monetary situations and with important consequences for the descriptive validity of theoretical one-sided target zone models.

Political competition and growth in global perspective: Evidence from panel data (pp. 363-382)

The present paper investigates the relationship between political competition, its components (executive versus legislature), and economic growth in international panel data. The results suggest the presence of a statistically significant nonlinearity between political competition (overall and in the executive) and growth in the form of a U-shape. In contrast, political competition variables do not exert statistically significant effects on growth in linear specifications. These results withstand an array of extensions and robustness checks, and provide international panel data evidence complementing work conducted for national and cross-sectional contexts.

Swimming pool versus art museum: Efficiency in the provision of local public facilities with heterogeneity (pp. 383-400)

This paper follows an approach adopted by Cremer, Marchand and Pestieau (1997) to analyze efficiency in the provision of heterogeneous local public facilities. Even when spillovers exist, under certain conditions the local government could still reach the optimum provision of the local public good, otherwise there is under-provision. Secondly, relaxing the non-excludability assumption, provision efficiency could be achieved if the local governments collect the service fees based on the neighboring community user’s net marginal willingness to pay. If not, the service fee mechanism would not always be able to eliminate the preexisting allocation inefficiency and could sometimes lead to increased inefficiency due to overprovision of the public good.

In several countries governments fund childcare provision but in many others it is privately funded as labor regulation mandates that firms have to provide childcare services. For this later case, there is no empirical evidence on the effects generated by the financial burden of childcare provision. In particular, there is no evidence on who effectively pays (firms or employees) and how (e.g., via wages and/or employment). Our hypothesis is that in imperfect labor markets, firms will transfer childcare cost on to their workers. To analyze this, we exploit a discontinuity in childcare provision mandated by Chilean labor regulation.

Social conflict and redistributive preferences among rich and poor: Testing the hypothesis of Acemoglu and Robinson (pp. 41-64)

Acemoglu and Robinson (2000) provide their hypothesis that the political elite extend the franchise to avoid revolution or social unrest. For the purpose of empirically testing this hypothesis, the present paper explores how the degree of conflict between rich and poor people is associated with individual preferences for income redistribution and perceptions regarding income differences. This paper used cross-country individual-level data covering 26 countries. The key findings are as follows: (1) an individual is more likely to prefer income redistribution policy in countries where people perceive conflict between rich and poor to be high; (2) an individual is more likely to consider the income difference to be too large in countries where people perceive conflict between rich and poor to be high; and (3) after dividing the sample into high- and low-income earners, the above two findings are only obtained for high-income earners and not for low-income earners.

A randomized impact evaluation of a tuition-free private school targeting low income students in Uruguay (pp. 65-94)

Using a randomized trial, we evaluate the impact of Liceo Jubilar, a tuition-free private school providing middle school education to poor students in Montevideo, Uruguay. The research compares adolescents randomly selected to enter the school with those not drawn in the school lottery. Several features of this school — the capacity to select personnel, a culture of high expectations, a safe and disciplined environment, differential teaching, extended instructional time, strong parental involvement, and a rich offer of extracurricular activities — contrast with the country’s highly centralized public education system. We find large positive impacts of Liceo Jubilar on students’ promotion rates and academic expectations. Our results shed light on new approaches to education that may contribute to improve opportunities for disadvantaged adolescents in developing countries.

This paper investigates the empirical relevance of both the hysteresis and the natural rate hypothesis on unemployment in three major economies, namely the UK, the US and Japan, by estimating the degree of dependence in the unemployment series. Both univariate and multivariate long memory methods are used. The results vary depending on whether the former or the latter approach is followed. Specifically, when taking a univariate approach, the unit root null cannot be rejected in case of the UK and Japanese unemployment series, and some degree of mean reversion (d < 1) is found in the case of the US unemployment rate. When applying multivariate methods instead, higher orders of integration are still found for the UK and Japanese series, but the natural rate hypothesis cannot be rejected in the case of the US.

This paper re-examines analyses of cross-country healthcare efficiency using modern, non-parametric estimators and Malmquist indices to determine productivity changes over the panel. This paper finds that cross-country heterogeneity leads to different efficiency rankings than previously thought, and that the hyperbolic order-α estimator leads to more robust efficiency scores when looking across different output measures, only looking at the more homogeneous OECD countries. It finds that the United States, if excluding the percent of healthcare expenditures that are publicly financed, is one of the more inefficient healthcare delivery systems in the world. What are commonly thought of as well-run healthcare systems (Austria and France) are either inefficient themselves or have variation in their efficiency rankings, showcasing difficulties in using other countries’ healthcare systems as models for reform. It also finds that there has been productivity regression in all countries except the United States. These highlight the difficulties in cross-country efficiency comparisons.

Evidence of political budget cycles from cross-country studies has been rationalized as coming from the voters’ cost to process the available information and asymmetric information. This explanation has also been adopted in most cross-province studies, leaving aside variables related to the incentive structure of fiscal federalism. This paper investigates electorally induced fiscal fluctuations in Argentina for the period 1985–2007. Provincelevel dynamic panel data reveal that vertical fiscal imbalances in subnational districts fuel fiscal expansion and changes in expenditure composition, favoring current expenditure to the detriment of investment, in election years. Vertical fiscal imbalances make electoral opportunism cheaper and more profitable.

Long-run determinants of economic growth in South America (pp. 169-192)

Based on an annual historical database for South American countries from 1960 to 2008, we develop an empirical study to gain insight into the long-run determinants of economic growth using a two-equation framework. A system of two panel data models is estimated to identify the growth determinants and their connection with foreign direct investment. We find that economic growth is driven most strongly by physical and human capital accumulation, as well as by sectorial exports, and that institutions and policy have a substantial impact on economic growth and investment. Macroeconomic disturbances have a significant detrimental effect on long-run growth. Trade openness correlates positively with foreign investment, indicating that relatively closed countries stand to benefit most from opening up their economies. Our division of the sample into two sub-periods, 1960–1980 and 1981–2008, indicates a structural change.

The Central Reserve Bank of Peru (BCRP) has been targeting inflation for more than a decade, using Lima’s inflation as the operational measure. An alternative indicator is countrywide inflation, whose quality and real-time availability have improved substantially. Given these competing measures, two policy questions arise: What have been the implications for national inflation of targeting Lima’s inflation? Would shifting to a national aggregate significantly affect the workings of monetary policy in Peru? To answer these questions, we estimate a large, but parsimonious, error correction model and investigate how regional shocks propagate across the country. The results indicate that a shock to Lima’s inflation is transmitted fast and strongly elsewhere in the country, whereas the effects of shocks in other regions are limited and short-lived. This constitutes supporting evidence to the view that by targeting Lima’s inflation, the BCRP has effectively, albeit indirectly, targeted national inflation.

This paper examines the causal relationship between economic policy uncertainty (EPU) and equity market uncertainty (EMU) in the US. We use daily data on the newly developed indexes by Baker et al. (2013a) covering 1985:01:01 to 2013:06:14. Results from the linear causality tests indicate strong bidirectional causality. However, the parameters stability tests show strong evidence of short-run parameter instability, thus invalidating any conclusion from the full sample linear estimations. Therefore we turn to nonlinear tests and observe a stronger predictive power from EMU to EPU than from EPU to EMU. Using sub-sample bootstrap rolling window causality tests to fully account for the existence of structural breaks, we find evidence that EPU can help predict the movements in EMU only around 1993, 2004 and, 2006. However, we find strong evidence that EMU can help predict the movements in EPU throughout the sample period barring around 1998, 2003 and 2005.

Luca De AngelisUniversity of BolognaAttilio GardiniUniversity of Bologna

Disequilibria and contagion in financial markets: Evidence from a new test (pp. 247-266)

This paper provides an analysis of contagion by measuring disequilibria in risk premium dynamics. We propose to test financial contagion using an econometric procedure where we first estimate the preference parameters of the consumption-based asset pricing model (C-CAPM) to measure the equilibrium risk premia in different countries and then we consider the difference between empirical and equilibrium risk premia to test crosscountry disequilibrium episodes due to contagion. Disequilibrium in financial markets is modeled by the multivariate DCC-GARCH model including a deterministic crisis variable. Our approach allows to identify the disequilibria generated by increases in volatility that is not explained by fundamentals but is endogenous to financial markets and to evaluate the existence of contagion effects defined by exogenous shifts in cross-country return correlations during crisis periods. Our results show evidence of contagion from the U.S. to U.K., Japan, France, and Italy during the crisis started in 2007-08.

Using a large panel data set, I find that political budget cycles are significantly smaller in countries with de facto central bank independence (CBI). To explain this result and its consequences in the economy, I develop an extended New Keynesian model that incorporates a political economy model of career concerns. I find that CBI mitigates the incumbent’s fiscal decisions. Intuitively, since increases in the interest rate have a negative effect on the reelection probability due to consumption postponement, this discourages expansionary fiscal policies.

We explore in a two-level gift-exchange experiment whether the managerial compensation influences workers’ effort decisions. Firstly, we find that there exists a strong positive relation between own wage and effort levels for the workers, while the managers’ effort reaches a maximum for intermediate wages and decreases for very high wages. Secondly, our data suggests that the managerial compensations are significantly negatively correlated with the workers’ effort choices: the higher the manager’s wage, the lower the effort level chosen by the workers.

The paper analyses whether people with low self-esteem are more likely to become unemployed than those with high self-esteem, and whether gender plays a moderating role in the relationship between self-esteem and becoming unemployed. The outcomes of a piecewise constant exponential model confirms our assumptions. Low self-esteem is highly significant in predicting the probability of becoming unemployed for women but not for men. However, low self-esteem has an effect on the chance of becoming unemployed regardless of gender for people in higher skills occupations.

The underground economy is an ambiguous concept: the literature presents a wide variety of definitions about it; the activities it encompasses are mobile and dynamic; and its structure has displayed several variations as time goes by. The present work aims to estimate a fuzzy number (a possible interval) for the size of the underground economy by applying structural equation modelling with fuzzy data. The proposed fuzzy model applied here involves two main steps, changing the structural equation model to a reduced form, then making a nonlinear model from reduced-form equations applying fuzzy linear regression concepts and solutions. Finally, the time series of the underground economy are obtained using the GAMS mathematical optimization software and compared with the findings of two MIMIC models and a microeconomic method.

Plugged in brokers: A model of vote-buying and access to resources (pp. 369-390)

Available formal models portray brokers as exploitative agents who buy their clients at the minimum possible price; that is, at voters’ reservation values. If this were the case then we should expect that poor voters be indifferent as to which broker they deal with, since they could expect the same minimum price from any broker. On the contrary, evidence of longterm broker-client relationships suggests that clients do care about who their broker is. The formal model in this paper, in correspondence with evidence drawn from 120 interviews with brokers, illuminates the reason why clients care about who their brokers are. Brokers are uncertain about voters’ reservation values. Due to this uncertainty, the more resources brokers obtain, the more they transfer to clients to assure their votes. Given this uncertainty over reservation values, voters benefit from brokers’ abilities to access more resources. These dynamics account for party machines’ frequent electoral hegemony.

Mauricio BugarinUniversity of BrasiliaAdriana PortugalTribunal de Contas do Distrito Federal

Should voting be mandatory? The effect of compulsory voting rules on candidates’ political platforms (pp. 1-20)

This article analyzes the effect of political participation in the electoral process on parties’ announced platforms in a model of electoral competition. The model highlights the existence of a class bias that favors groups of voters with higher turnout. There exists empirical evidence that wealthier economic classes present higher levels of political participation. In that situation, the model suggests that compulsory voting may be a useful mechanism to reduce the bias in favor of the higher-turnout class.

In the nineties Argentina implemented a large education reform (Ley Federal de Educación – LFE) that mainly implied the extension of compulsory education in two additional years. The timing in the implementation substantially varied across provinces, providing a source of identification for unraveling the causal effect of the reform. The estimations from difference-in-difference models suggest that the LFE had a positive impact on years of education and the probability of high school graduation. The impact on labor market outcomes —employment, hours of work and wages— was positive for the non-poor youths, but almost null for the poor.

We examine the effects of several alternative measures intended to reduce government deficits for the case of Spain, distinguishing between those acting through taxes and through spending. The Spanish case is relevant as an example of front-loaded fiscal adjustment that has led to a large GDP fall, where (unlike the cases of Greece, Ireland and Portugal) the authorities were able to choose the composition of the adjustment measures. The empirical methodology is based on a computable general equilibrium model. All the simulated policies lead to a decrease in the levels of output and employment, and to a higher unemployment rate. The greatest contractionary effects appear in the case of an increase in the income tax, followed by spending cuts, especially in public education; in contrast, the contractionary effect is weaker for indirect tax increases. While income distribution for labour worsens with spending cuts, it slightly improves with tax increases.

This paper assesses the effects of fiscal consolidations associated with public debt reduction on medium-term output growth during periods of private debt deleveraging. The analysis covers 107 countries and 79 episodes of public debt reduction driven by discretionary fiscal adjustments during the 1980–2012 period. It shows that expenditure-based, front-loaded fiscal adjustments can dampen growth when there are credit supply restrictions. Instead, fiscal adjustments that are gradual and rely on a mix of revenue and expenditure measures can support output expansion, while reducing public debt. In this context, protecting public investment is critical for medium-term growth, as is the implementation of supply-side, productivity-enhancing reforms.

The adverse effects of real exchange rate variability in Latin America and the Caribbean (pp. 99-120)

The paper examines the pros and cons of anticipated appreciation and the asymmetric effects of short-term exchange rate fluctuations in a sample of countries in Latin America and the Caribbean. On the demand side, exchange rate depreciation increases competitiveness and export growth, expanding output growth. On the supply side, depreciation increases the cost of imported inputs, increasing output capacity constraints and accelerating price inflation. The time-series evidence indicates that output expansion (contraction) and price deflation (inflation) predominate with anticipated currency appreciation (depreciation). The cross-country results show that exchange rate variability exacerbates the variability of economic activity across countries. Short-term fluctuations of the exchange rate may reflect the adverse effects of unanticipated currency fluctuations. Therefore, more flexibility towards aligning the real effective exchange rate with the underlying fundamentals could help mitigate the adverse effects of higher cost of imports and loss of competitiveness on real growth, and ease inflationary pressures.

Small sample properties of Bayesian estimators of labor income processes (pp. 121-148)

There exists an extensive literature estimating idiosyncratic labor income processes. While a wide variety of models are estimated, GMM estimators are almost always used. We examine the validity of using likelihood based estimation in this context by comparing the small sample properties of a Bayesian estimator to those of GMM. Our baseline studies estimators of a commonly used simple earnings process. We extend our analysis to more complex environments, allowing for real world phenomena such as time varying and heterogeneous parameters, missing data, unbalanced panels, and non-normal errors. The Bayesian estimators are demonstrated to have favorable bias and efficiency properties.

Esteban SanromáIEB, University of BarcelonaRaúl RamosAQR-IREA, University of BarcelonaHipólito SimónIEI, Universidad de Alicante & IEB

How relevant is the origin of human capital for immigrant wages? Evidence from Spain (pp. 149-172)

The objective of this article is to analyse the role played by the different components of human capital in the wage determination of immigrants in the Spanish labour market. Using microdata from the Encuesta Nacional de Inmigrantes, we find that human capital of immigrants acquired in Spain presents higher returns than human capital obtained in home countries, reflecting the limited international transferability of the latter. This result is reinforced by the strong heterogeneity observed in wage returns to different kinds of human capital across immigrants from different origins and, in particular, by the fact that immigrants with the higher returns to human capital acquired in their home countries are those coming from other developed countries and Latin America, the two regions more similar to Spain in terms of development and/or culture.

This paper considers the use of two machine learning algorithms to identify the causal relationships among retail prices, manufacturer prices, and number of packages sold. The two algorithms are PC and Linear Non-Gaussian Acyclic Models (LiNGAM). The dataset studied comprises scanner data collected from the retail sales of carbonated soft drinks in the Chicago area. The PC algorithm is not able to assign direction among retail price, manufacturer price and quantity sold, whereas the LiNGAM algorithm is able to decide in every case, i.e., retail price leads manufacturer price and quantity sold.

The introduction of the euro and economic growth: Some panel data evidence (pp. 199-212)

We use a difference in difference estimation framework to analyse the effects of the adoption of the euro on the level of per capita GDP for a sample of seventeen European countries (the EU15 plus Norway and Iceland) over the period 1990–2010. We find that the adoption of the euro may have raised the level of per capita GDP (and labour productivity) by about 4 percent. There is also some evidence that the impact of the euro has been smaller in the case of countries with a high debt-to-GDP ratio in 1999 when the euro was introduced. Results are robust to controlling for country fixed effects, time trends and to estimation strategies that control for cross-country parameter heterogeneity.

Are there more female managers in the retail sector? Evidence from survey data in developing countries (pp. 213-228)

Using firm-level data for 87 developing countries, the paper analyzes how the likelihood of a firm having female vs. male top manager varies across sectors. The service sector is often considered to be more favorable towards women compared with men vis-à-vis the manufacturing sector. While our exploration of the data confirm a significantly higher presence of female managers in services vs. manufacturing, the finding is entirely driven by the retail firms with little contribution from other service sectors such as wholesale, construction and other services. We also find that the greater presence of female managers in the retail sector vs. manufacturing is much higher among the relatively small firms and firms located in the relatively small cities. These findings could serve as useful inputs for the design of optimal policy measures aimed at promoting gender equality in a country.

On the optimality of bank capital requirement policy in a macroeconomic framework (pp. 229-256)

An increasingly widespread “macro-prudential” view holds that bank capital requirements should be loosened during recessions and tightened during expansions to avoid excessive credit and output swings. We present a dynamic general equilibrium framework that accounts for the effects of capital requirement policies on the saving decisions of households, and, through this channel, on bank loans and output. We evaluate optimal capital requirement policy in the presence of loan write-offs (loan supply) and productivity (loan demand) shocks. We show that capital requirements should be reduced in response to unanticipated loan write-offs. We also show that capital requirements should be tightened in anticipation of future declines in productivity, and loosened at the onset of recessions. We conclude that macro-prudential capital requirement policies can be optimal from a welfare standpoint, but they can also generate output and credit booms through general equilibrium effects.

State dependence of aggregated risk aversion: Evidence for the German stock market (pp. 257-282)

We propose a dynamic generalization of the Capital Asset Pricing Model (CAPM) that allows for a time-varying market price of risk (MPR) reflecting both cross market dependence and future investment opportunities. The realized volatility approach is employed to determine market risk. The advocated state space model takes autoregressive dynamics of the MPR and predetermined state variables into account. For the case of the DAX, the major German stock index, the empirical analysis strongly underpins time variation of risk compensation. The MPR is conditioned upon the EURIBOR, a national and an international term spread, returns of the Dow-Jones-Industrial-Average-Index (DOW), and a dummy variable hinting at excess activity of noise traders. Moreover, we document forecasting results based on a short horizon trading strategy. The proposed model is characterized by strong market timing ability.

This paper investigates the existence of common movements between nominal and real exchange rates across different countries in three regions – North America, Western Europe, and Central and Eastern Europe – by using the multi-factor model. It also examines the role of macroeconomic fundamentals (i.e., prices, money and output) in order to explain the variance of the exchange rate global factor. The findings suggest the existence of co-movements among exchange rates. The exchange rate global factor seems to play a central role in explaining exchange rate variability in Western Europe, whereas regional and country-specific factors are the most important ones in North America and Central and Eastern Europe, respectively. Finally, the paper shows empirical evidence in favour of the connection between exchange rate global factor variability and macroeconomic fundamentals. Moreover, the importance of fundamentals has increased in the recent global crisis.

Financial stability, competition and efficiency in Latin American and Caribbean banking (pp. 301-324)

Using a sample of 272 commercial banks from fifteen Latin American countries for the period 2001-2008, we estimate cost and revenue efficiency scores, financial stability scores (Z-scores) and competition scores (Lerner indexes and Boone indicators) at the bank level. The Granger causality technique in dynamic panels is used to establish dynamic relationships among these variables. We find evidence that strongly supports the “quite life” hypothesis, while we also find partial support for causality running in the opposite direction. Moreover, the results suggest that more competition is conducive to greater financial stability (when the revenue efficiency score is used). Banks seem to achieve market power through better efficiency, leverage and earning ability. As size and complexity increase, however, agency problems and increasing risk-taking might start gaining momentum, generating inefficiency and fragility.

Housing is a major component of aggregate demand, and understanding how the demand for housing co-varies with income is useful for analysis and policy. While estimating housing consumption for tenants amounts to observing rents, estimating housing consumption for owner-occupiers is challenging because it is not directly observable and interest payments vary with re-paid principals. In order to examine the housing consumption for owneroccupiers, this article combines micro data sets on income and imputed rents for owneroccupiers based on home attributes from a consumer expenditure survey and monthly rents in a rental survey. This allows estimation of an Engel curve of owner-occupied consumption, both parametrically and non-parametrically. Regression results demonstrate that the income share of owner-occupied housing consumption decreases with income, while the Engel elasticity computed at the mean is 0.32 and increasing in income.

Peter A. PrazmowskiAmerican Chamber of Commerce of the Dominican Republic and Grupo León JimenesJosé R. Sánchez-FungUniversity of Nottingham, Ningbo, and ILAS, University of London

Assessing the impact of different nominal anchors on the credibility of stabilisation programmes (pp. 353-372)

The paper compares the impact of announcing exchange rate-based versus money-based stabilisation programmes in a time series cross-section of countries. The analysis finds that, on average, the effect of announcing exchange rate-based programmes is more credible, in terms of reducing inflation inertia, than the outcome associated with money-based programmes. The econometric analysis is robust to augmenting the benchmark inflation model with measures of the size of IMF-programme loans and the timing of government elections. The paper also finds that the gap between the magnitudes of the impacts from pursuing the different strategies has been falling since the 1970s. The trend seems compatible with the much debated Great Moderation in advanced economies and similar developments in economies around the world.

On the structure of financial contagion: Econometric tests and Mercosur evidence (pp. 373-400)

We introduce a flexible copula-based semi-parametric test of financial contagion that is capable of capturing structural shifts in the transmission channel of shocks across a network of financial markets beyond the increase in the intensity of time-varying dependence. We illustrate the capabilities of the proposed test using returns of stock, money, sovereign debt, and foreign exchange markets of seven Latin-American countries, and test for the presence of pure contagion effects for each major financial crisis that affected the Mercosur region between 1994 and 2001. Besides strong evidence in favor of time-varying market interdependence, we cannot rule out the presence of pure contagion effects in the stock market transmission channel associated with the Mexican, Asian, and Russian financial crises.

This paper analyses the validity of second generation endogenous growth theories for six developed countries and ten manufacturing sectors over the period 1979-2001, applying modern tests and estimation procedures for the treatment of panel data. The basic autonomous innovation-driven model is extended to include international technology transfer and different measures of absorptive capacity. The estimates give great support to semi-endogenous growth theory. Furthermore, Schumpeterian or fully-endogenous growth theory has some support in the high impact of distance to the frontier variable which represents autonomous technology transfer.

Senay AcikgozGazi University and Rensselaer Polytechnic InstituteMerter MertGazi University

Sources of growth revisited: The importance of the nature of technological progress (pp. 31-62)

Traditional sources of growth studies generally assume that the nature of technological progress is Hicks-neutral. However, the nature of technological progress compatible with steady state conditions is Harrod-neutral rather than Hicks-neutral. This study thus investigates sources of growth for Hong-Kong, the Republic of Korea, Singapore and Taiwan using the bounds testing procedure of Pesaran, Shin and Smith (2001) and the autoregressive distributed lag (ARDL) approach of Pesaran and Shin (1999). The robustness of the test results and parameter estimates are also justified by the fully modified ordinary least squares approach of Phillips and Hansen (1990). The results emphasize that the fundamental source of economic growth is technological progress in the short-run.

This study investigates the major determinants of international capital flows in selected countries in Sub-Saharan Africa. Both theory and the empirical literature suggest that financial liberalization and regionalism lead to higher levels of capital inflows. By using a dynamic panel data analysis, this research tests these hypotheses. The impact of financial liberalization depends on the type of liberalization implemented. Liberalization of the domestic financial system and the domestic equity market has a positive and significant impact on international capital flows. Aggregate capital account liberalization is not significant, but the elimination of multiple exchange rates significantly affects international capital flows, while other components have a more limited impact: the liberalization of inward FDI directly increases foreign direct investments, whilst the deregulation of offshore borrowing directly causes an increase in foreign debt inflows. Regionalism causes an increase in foreign direct investment inflows but does not affect other forms of capital inflows.

Many developing countries are allocating significant resources to expand technology access in schools. Whether these investments will translate into measurable educational improvements remains an open question because of the limited existing evidence. This paper contributes to fill this gap exploiting a large-scale public program that increased computer and internet access in secondary public schools in Peru. Rich longitudinal school-level data from 2001 to 2006 is used to implement a differences-in-differences framework. Results indicate no statistically significant effects of increasing technology access in schools on repetition, dropout and initial enrollment. Large sample sizes allow ruling out even modest effects.

Nonconventional provisions in regional trade agreements: Do they enhance international trade? (pp. 113-138)

The scope of recent regional trade agreements (RTAs) has become much broader than before by the inclusion of nonconventional provisions such as those on competition policy and intellectual property rights protection. This paper empirically examines the extent to which those nonconventional provisions in RTAs enhance international trade between RTA member countries by estimating a gravity equation with detailed information on the contents of RTAs. We find that the provision for competition policy has the largest effect on international trade, followed by the government procurement provision. These two provisions have significant and positive impacts on intensive margin intensive margin (trade values per variety) and extensive margin (number of varieties traded)

We study terrorist choice from the perspective of economics and psychology. Using RANDMIPT data about the injuries and fatalities inflicted by different terrorist attack methods, we compute sets of preference orderings over the attack methods using prospect theory. This incorporates reference point dependence, risk seeking in the domain of losses, risk aversion in the domain of gains, non-linear preferences and loss aversion into an analysis of terrorist behaviour. We pay particular attention to the importance of a reference point in the context of ‘copycat’ acts of violence and the influence of loss aversion on the choice of attack method. Our results provide an indication of the types of attack methods that would be chosen by a terrorist whose decision-making process is described by prospect theory and who might, for example, seek to emulate or surpass the actions of a predecessor.

National electoral cycles in transfers to subnational jurisdictions. Evidence from Argentina (pp. 161-178)

The political budget cycle literature studies the periodic fluctuations in governments’ fiscal policies induced by the cyclicality of electoral processes, but the effects of elections on the distribution of federal resources among subnational governments has not been thoroughly investigated. This paper inquires into the presence of electoral cycles in federal government transfers, presenting evidence on how the Argentine national government has allocated, since the reestablishment of democracy in 1983, two different types of discretional transfers — cash and in-kind — among the subnational governments. There is an electoral manipulation of total transfers that favors subnational governments that are politically affiliated to the national government; cash transfers show that same pattern. However, inkind transfers, which are more traceable to the national government than cash transfers, increase in non-affiliated subnational jurisdictions during election years.

Bedri Kamil Onur TaşTOBB University of Economics and TechnologyHüseyin Ekrem CunedioğluEconomic Policy Research Foundation of Turkey

How can recessions be brought to an end? Effects of macroeconomic policy actions on durations of recessions (pp. 179-198)

This paper analyzes how effective macroeconomic policy actions are in ending recessions. We also investigate which structural factors help the country to experience shorter recessions. We implement survival regression analysis and conclude that expansionary monetary policy significantly decreases durations of recessions whereas fixing the exchange rate does not have an effect on the durations of recessions. Expansionary fiscal policy has undesired effects and decreases the probability that recession will end, thus increasing the durations of recessions. The analysis of country specific factors indicates that emerging countries experience shorter recessions. Recessions in countries with higher trade openness last significantly longer. Financial openness and institutional quality do not have significant effects of recession durations. The empirical analysis takes into account alternative probability distributions and endogeneity of policy actions.

The (formal) return to openness: A quantitative contribution to the history of economic thought (pp. 203-222)

We develop a comprehensive quantitative account of changing practices in economics in the last 122 years. The analysis uses word detection algorithms to partially characterize prevailing practices. We document a shift toward isolation from other disciplines during most of the twentieth century. In sharp contrast, the most recent decades show a strong move towards a more connected discipline. Periods of more connectedness are associated with openness to a broader set of features of economic agents and the economic environment. In parallel, the 1960s and 1970s show a notable acceleration in the move towards a more mathematical approach. This development did not reverse. As a result, the current state of the discipline is characterized by an embrace of mathematical tools together with openness to a wider set of aspects and findings developed in other disciplines. Most of the reported variables show surprisingly high correlations across disciplines and across journals. An online appendix is available.

We study consequences of regulatory interventions in limit order markets that aim at stabilizing the market after an occurrence of a “flash crash”. We use a simulation platform that creates random arrivals of trade orders, that allows us to analyze subtle theoretical features of liquidity and price variability under various market structures. The simulations are performed under continuous double-auction microstructure, and under alternatives, including imposing minimum resting times, shutting off trading for a period of time, and switching to call auction mechanisms. We find that the latter is the most effective in restoring the liquidity of the book and recovery of the price level. However, one has to be cautious about possible consequences of the intervention on the traders’ strategies, including an undesirable slowdown of a convergence to a new equilibrium after a change in fundamentals.

Does Ricardian equivalence hold? The relationship between public and private saving in Spain (pp. 251-274)

This paper aims to test the validity of the Ricardian proposition for the Spanish economy in two different frameworks: a) in traditional structural consumption equations and, b) in consumption functions stemming from Euler equations derived from a consumer’s maximization problem. Our results lean toward rejection of the Ricardian proposition, although some degree of substitution between public and private saving is detected. Moreover, we provide some evidence of consumers becoming increasingly Ricardian with the level of government indebtedness as it may trigger sustainability concerns. In terms of policy implications, these results would suggest that until 2007 fiscal policy in Spain enjoyed some room of manoeuvre to exert its countercyclical role. The sovereign debt crisis has exhausted such margin. An online appendix is available.

Technological diffusion via FDI is essential for the economic growth of backward economies. However, institutional and policy barriers may slow down technology diffusion. Using a simple theory based on Acemoglu (2009), we predict that inward FDI (pool of available world frontier technologies) and financial deregulation (enhancing absorptive capability via lowering institutional and policy barriers) have a complementary effect on economic growth. We test the predictions using panel data on Chinese provinces during the reform and opening-up period. The Chinese experience is appealing because of the symbiotic financial deregulation and inflow of FDI. We find robust evidence that there is a significant interaction effect between FDI and the level of financial deregulation that promotes economic growth. This furthers our understanding of the reform and opening-up strategy of China.

Using choice experiments to value a world cultural heritage site: Reflections on the experimental design (pp. 303-332)

In the context of public amenities, whose benefits of preservation are not totally reflected by the market, the valuation of cultural heritage has given primacy to the contingent valuation method, with very few attempts being made to valuation via the discrete choice experiments technique (DCE). In the present paper, from among the various phases of the DCE conception, particular emphasis is given to the way in which the attributes levels are combined into alternatives and how they are allocated into choice sets (experimental design step). In order to configure hypothetical scenarios relating to the conservation of a World Heritage cultural landscape, this paper applies both the experimental design strategies identified in the literature review as commonly applied in DCE to value cultural items, as well as D-optimal processes, which proved to be advantageous both in terms of statistical efficiency and in the information required (number of choice sets).

This paper studies the connection between economic policy and electoral outcomes. In particular, it analyzes the impact of the conflict between the agro-manufacturing sector and the national government on the congressional elections for national deputies in the 134 municipalities of the province of Buenos Aires — a conflict which stemmed from the increase in taxation and the imposition of quantitative restrictions on the sector’s production and exports. The municipalities differ greatly in their productive structures; therefore, a policy that is detrimental (beneficial) to a certain sector of activity may be expected to have a greater negative (positive) impact on the election results for the governing party in those municipalities where that sector is quantitatively important. The estimations show that the relative importance of the agro-manufacturing sector, controlling for economic, social and political variables, had a positive impact on the party in office in 2007 and a negative one in 2009. An online appendix is available.

Armando Sanchez-VargasNational Autonomous University of MexicoRicardo Mansilla-SanchezNational Autonomous University of MexicoAlonso Aguilar-IbarraNational Autonomous University of Mexico

An empirical analysis of the nonlinear relationship between environmental regulation and manufacturing productivity (pp. 357-372)

The relationship between environmental regulation and productivity has been broadly analyzed. Here, we propose the use of one member of the family of exponential Gumbel distributions in order to study a potential nonlinear relationship between environmental regulation and manufacturing productivity in Mexico using a data set at the plant level. We show that the link between environmental regulation and productivity is in fact nonlinear and that there is a decreasing trade-off between those variables in the manufacturing industry. We find that such trade-off is high for small firms, but almost negligible for large companies. Thus, we argue that much of the debate on different effects is due to the heterogeneity of the industry. This result might be useful for the design of policies devoted to enhancing environmental performance.

Money-price relationships under a currency board system: The case of Argentina (pp. 373-390)

The relationship between money and prices, and the endogenous money hypothesis, is examined within the framework of a currency board-like system by using monthly data for the Argentinean economy in the period 1991-2001. Employing exogeneity tests, the empirical findings support the endogenous money hypothesis for the relationship between monetary variables (M1, M2, monetary base) and the producer price index, but reject it when the consumer price index is used instead as price variable.

Carlos ScartasciniInter-American Development BankErnesto SteinInter-American Development BankMariano TommasiUniversidad de San Andrés

Political institutions, intertemporal cooperation, and the quality of public policies (pp. 1-32)

While economists have tended to focus on specific public policies when developing recommendations, the achievement of welfare objectives might depend more on the quality of policies than their content. This paper develops several measures of the qualities of policies across countries, arguing that the quality of public policies depends on each polity’s ability to strike intertemporal transactions necessary to develop and sustain effective policies. The analytical framework developed here indicates that this ability depends on several characteristics of political institutions, such as congressional capabilities, judicial independence, and bureaucratic independence and professionalism. The empirical evidence presented supports this idea. An online appendix is available.

Mohsen Bahmani-OskooeeUniversity of Wisconsin-MilwaukeeJia XuSt. Mary’s College of Maryland

The S-curve dynamics of U.S.-Mexico commodity trade (pp. 33-48)

In testing the short-run effects of currency depreciation on the trade balance, rather than engaging in regression analysis, part of the literature basically looks at the correlation coefficients between past and future values of the trade balance and the current exchange rate. It is postulated that these coefficients are positive between future values of the trade balance and current exchange rate, but negative between past values of the trade balance and the current exchange rate, hence the S-Curve pattern. Previous research has shown that the curve is not supported for Mexico when aggregate trade data are used. In this paper we used bilateral trade data between Mexico and her main partner, the United States to test the curve. Still there was no support for the curve. However, when we disaggregated bilateral trade flows by industry and considered the trade balances of 223 industries that trade between the two countries, we were able to support the S-Curve in 90 industries.

This paper studies the relation between inflation and relative price variability (RPV) in Spain during the 1987-2009 period. We find that this relation presents a U-shape profile, and that the optimal annual inflation rate (defined as the one that minimizes RPV) is around 4%, higher than the 2% inflation target proposed by the European Monetary Union. More importantly, this result does not depend on whether the monetary regime is before or after the euro. Hence, the main policy implication is that disinflation efforts to achieve the 2% inflation target result in welfare losses. The key link between inflation and RPV is unexpected inflation, whose optimal level is around zero. This suggests that monetary policy matters: the welfare costs associated with higher RPV can be minimized with a credible and predictable inflation targeting policy set at the appropriate level. An online appendix is available.

Based on Cheung, Chinn and García-Pascual (2004) and Meese and Rogoff (1983), the forecasting performance of a wide variety of theoretical and empirical exchange rate models (PPP, UIP, flexible and sticky-price monetary models, portfolio balance, and a BEER model) is tested against the random walk specification to determine their assessment in predicting the quetzal–U.S. dollar nominal exchange rate. Such models are estimated by applying a recursive regression methodology to quarterly data for the period 1995-2009. Estimations are performed based on an innovative trend-gap data disaggregation methodology, and an error-correction specification to contrast short vs. long run prediction performance, which is evaluated up to eight periods ahead for all model specifications. Different from previous results, forecasts provided by most specifications in the very short run (up to 2 quarters ahead), particularly the BEER specification, consistently outperform those obtained from the random walk model. An online appendix is available.

Jose Angelo DivinoCatholic University of BrasiliaLuis Felipe Vital Nunes PereiraCatholic University of Brasilia

Are increases in government spending neutral? Evidence from Latin-American households (pp. 101-120)

Using a dynamic optimization model, Ricardian Equivalence (RE) is empirically tested for Argentina, Brazil, Chile and Mexico. The system of equations obtained in the theoretical model is solved using Generalized Method of Moments and Full Information Maximum Likelihood. Results indicate that the null hypothesis concerning RE cannot be rejected for Argentina, Brazil, and Chile but is strongly rejected for Mexico. Therefore, when the fiscal authority seeks to stimulate economic activity by means of tax reductions and increases in government spending, the outstanding effect might be only a rise in private savings for the first three countries.

This paper studies the transmission of monetary policy through the bank-lending channel in a partially dollarized banking system. Taking advantage of the cross-sectional and timeseries variation in individual Mexican bank balance sheets, I find that the deposits and loans of banks that have a larger share of foreign currency deposits are less sensitive to domestic monetary shocks, particularly for small banks. The results also suggest that banks with a larger foreign deposit share are more sensitive to foreign (U.S.) monetary shocks and Mexican country risk. The results indicate a novel way in which monetary policy has real effects in a partially dollarized economy: Not only are banks unable to easily replace insured deposits with other sources of funds because of information frictions (the conventional bank lending channel), but they are also unable to fully offset a loss of domestic currency deposits with foreign currency deposits. An online appendix is available.

Sergio TezanosUniversity of CantabriaAinoa QuiñonesUniversity of CantabriaMarta GuijarroUniversity of Cantabria

Inequality, aid and growth: Macroeconomic impact of aid grants and loans in Latin America and the Caribbean (pp. 153-177)

Aid effectiveness in Latin America and the Caribbean (LAC) has been little studied, despite the fact that it is the developing region receiving foreign aid with the highest per capita income and inequality levels. This paper uses a growth regression model to analyze the impact of Official Development Assistance (ODA) in LAC. We evaluate ODA effectiveness in relation to the growth rate of an ‘inequality-adjusted GDP per capita’ in order to precisely define the desired impact of aid in a region with high levels of inequality. The estimation produces three main results: aid is effective, in aggregated terms, once we deal with the effect of income inequalities; the impact of concessional loans seems to be

Aggregate business failures and macroeconomic conditions: A VAR look at the U.S. between 1980 and 2004 (pp. 179-202)

In this paper, we study the U.S. aggregate business failures during 1980- 2004 in relation to four macroeconomic variables: aggregate corporate profits, the producer price index, the interest rate, and stock market performance. We argue that aggregate business failures should not be treated as a passive variable, as usually done in previous studies, and we allow its possible causal effect on other macroeconomic variables through a Structural Vector Autoregression model that builds on Directed Acyclic Graphs. Granger type causality and innovation accounting results both show that while subject to the influence of interest rates, aggregate business failures are quite exogenous in comparison to the other three variables. The implications of these findings are discussed as well.

Governments can finance fiscal expansions with debt to appear competent and boost their electoral prospects, resulting in a political budget cycle. This article shows that economic disturbances blur competence signals, dampening political budget cycles. Economic disturbances can be construed at the aggregate level as economic volatility which is a consequence of decisions taken by diverse economic actors. The more actors that are not elected at the national level have an impact on economic performance, the more difficult it will be for voters to disentangle government-specific competence shocks. Fiscal decentralisation increases policy leverage of governing bodies that are not elected at the national level; economic openness affects the number of foreign economic actors that cannot be held locally accountable. These two factors therefore limit voters’ ability to disentangle individual shocks to government competence, dampening strategic borrowing. The predictions receive empirical support from a time series-cross section analysis between 1980 and 2008.

This paper analyzes the unemployment dynamics of 18 Latin American countries for the last four decades. We use a time series approach to test the mean reversion of unemployment rates and its approximation to a Natural Rate of Unemployment (NRU). The tests include the possibility of one and two structural changes to account for the occurrence of significant macroeconomic changes experienced by the Latin American economies. In addition, we estimate the order of integration of the series, allowing for fractional degrees of differentiation, to assess the persistence of unemployment in the region. Our results indicate that when endogenous structural changes are included in the model, in general we find evidence of mean reversion of unemployment rates for the Latin American countries under study. Therefore, our findings support the structuralist hypothesis of unemployment.

We estimate the economic value of the urban cultural heritage of Valdivia, Chile, an emblematic historical city that comprises an ensemble of disperse cultural heritage elements. To derive its economic value we use the preferences stated by residents. The contingent valuation method with parametrical estimation (probit bivariate models) is applied, consisting of a survey employing double-bounded questions. The paper contributes to broadening the spectrum of case studies in this line of research in developing countries. It also seeks to determine which socioeconomic and demographical factors of interviewees prove significant when estimating willingness to pay (WTP). WTP is significant, although it reveals a slight drop as the degree of certainty of actually making a payment, in accordance with the hypothetical valuations that are stated, increases. WTP is positively related to educational qualifications and cultural habits, but there seem to be no major differences in terms of urban distribution.

Monetary policy rules in a small open economy: an application to Mexico (pp. 259-286)

We estimate a small-scale macro model for the Mexican economy under the New Keynesian (NK) framework and alternative interest rate rules for Mexico. With these results we evaluate the performance of the Bank of Mexico against a set of optimality principles derived in the NK literature. Our system estimation results show that the Bank of Mexico holds a preference for stabilizing not only inflation around target, but also acts to achieve an output gap close to zero. Furthermore, we find that the central bank responds non-linearly to real exchange rate depreciations. We also find that the central bank has actively attempted to neutralize demand and supply shocks through monetary policy that is consistent with the Taylor principle.

Giovanni CerulliCNR-Ceris (National Research Council of Italy, Institute for Economic Research on Firms and Growth)Bianca PotìCNR-Ceris (National Research Council of Italy, Institute for Economic Research on Firms and Growth)

Evaluating the robustness of the effect of public subsidies on firms’ R&D: an application to Italy (pp. 287-320)

This paper applies different econometric methods to evaluate the effect of public subsidies on firms’ R&D activity. For the sake of robustness, results from the Heckman selection model (Heckit), Control-function regression, Difference-in-differences, and various Matching methods are compared by using the third and fourth wave of the Italian Community Innovation Survey (CIS3, years 1998-2000 and CIS4, years 2002-2004). We predict the absence of a full crowding-out of private R&D performance, both for the whole sample and for some subsets of firms. Nevertheless, we conclude that while for variables expressed as ratio (R&D intensity and R&D per employee) the difference in results is negligible, R&D expenditure presents a strong variability among the approaches, even for those relying on similar identification assumptions. Given the utmost importance of this target-variable, future works should go beyond the use of single methods, especially when they are thought of to steer future policymaking.

Political parties as a commitment technology: effects of term limits on vote share (pp. 321-351)

Building on models of electoral competition with reputational mechanisms, I show that term limits decrease the vote share of candidates from parties less able to reward or punish candidates. Candidates suffer by not being able to credibly commit to policies far from their own preferences. Assuming that the major parties can provide better discipline of their members than third parties, the implication of the model is that third party candidates will be worse off, in terms of vote share garnered, in elections for offices with term limits. The hypothesis that third parties do worse under term limits is tested using state gubernatorial elections. Data from 1977-2008 show the vote share of third party candidates is approximately six percent lower in elections for a term-limited office when controlling for other election characteristics and regional and temporal trends in party popularity.

Ashok K. MishraLouisiana State University AgCenter and Louisiana State UniversityHiroki UematsuLouisiana State University AgCenter and Louisiana State UniversityRebekah R. PowellLouisiana State University AgCenter and Louisiana State University

Precautionary wealth and income uncertainty: a household-level analysis (pp. 353-369)

This study investigates the presence of precautionary savings among self-employed farm households using an instrumental variable approach on farm-level data. Results indicate that precautionary saving is a powerful determinant of wealth accumulation among U.S. farm households. Precautionary savings account for 53% of total wealth accumulation in general. Our results indicate an age-wealth profile that is consistent with the life-cycle hypothesis. The share of precautionary saving in total wealth accumulation differs across farm households. Results show that for farm households receiving government payments (designed to benefit farmers by reducing income variability), precautionary saving account for a large share (51%) of wealth accumulation, compared to 41% for households that do not receive any government payments.

Estimation of relative bargaining power in markets for raw milk in the United States (pp. 1-23)

This study contributes to the empirical industrial organization literature by deriving and estimating the empirical equation containing the parameter for bargaining power and an indicator of competition between suppliers. We specify a reduced form of the price equation, which is composed of the minimum price specified in milk marketing orders and the reduced form of the upper bound for the price in regional raw milk markets in the United States. Estimation results indicate that the relative bargaining power of dairy cooperatives in setting regional raw milk prices is small compared to the power of milk bottlers. We find the price differential in milk marketing orders has contributed to raise the price bargained between dairy cooperatives and milk bottlers.

Leisure and the net opportunity cost of travel time in recreation demand analysis: An application to Gros Morne National Park (pp. 25-49)

Using count data models that account for zero-truncation, overdispersion, and endogenous stratification, we estimate the value of access to recreational parks. The focus is on the empirical estimation of the proportion of the wage rate that best approximates park visitors’ opportunity cost of travel time within the cost of their trip and its effects on estimated consumer surplus. The fraction of hourly earnings that corresponds to the opportunity cost of travel time is endogenously estimated as a function of visitor characteristics, rather than fixed exogenously. In this case, which deals with a relatively remote recreational site, the relevant opportunity cost of time for most visitors appears to represent a smaller fraction of their wage rate than commonly assumed in previous similar studies.

The impact of financial development and trade on the economic growth of Bolivia (pp. 51-70)

The relationship of economic growth with financial development and trade openness is analyzed with annual time-series data for Bolivia during the 1940-2010 period. The analysis is an advance over previous work in several ways. First, the hypothesis of a long-run relationship between these variables is tested using bivariate cointegrated systems and employing the methodology of cointegration analysis. Second, causality tests utilizing standard Granger regressions and ECM models are carried out to determine the direction of causality between indicators of economic growth and financial development, and economic growth and trade openness. Lastly, the study comprises a period of seventy years, a first for a study of this kind on Bolivia. The empirical results demonstrate that there is indeed a long-run equilibrium relationship, and that unidirectional Granger causality runs from the indicators of financial development and trade openness to economic growth.

The link between inflation and inflation uncertainty is evaluated using Peruvian data, in a context of changing monetary policies because of regime shifts. A Markov regime-switching heteroskedasticity model that includes unobserved components is used. The model shows how periods of high (low) inflation accompany periods of high (low) short- and long-run uncertainty in inflation. The results of the model also illustrate how, during the recent period of price stability in Peru, both permanent and transitory shocks in inflation show a decrease in volatility. Finally, a time-varying measure of inflation uncertainty is derived from the estimates, giving additional evidence on the positive link between the level of inflation and its uncertainty.

This paper represents the first contribution that investigates the economic value of Catalan knowledge in terms of earnings, focusing on national and foreign first- and second-generation immigrants in Catalonia. Specifically, drawing on data from the Survey on Living Conditions and Habits of the Catalan Population (2006), we quantify the expected earnings differential between individuals who are proficient in Catalan and those who are not, taking into account the potential endogeneity between knowledge of Catalan and earnings. The results indicate the existence of a positive return to knowledge of Catalan, with a 7.5% increase in earnings estimated by OLS. When we account for the presence of endogeneity, monthly earnings are around 18% higher for individuals who are able to speak and write Catalan. We also find that language and education are complementary inputs for generating earnings in Catalonia, given that knowledge of Catalan increases monthly earnings only for more educated individuals.

Nasser KhiabaniInstitute for Management and Planning StudiesMehdi HamidisahnehCarlos III University of Madrid

The effects of entry regulation on bank competition: The case of the Iranian banking industry (pp. 119-137)

We focus on a modified version of the markup test to investigate the impact of entry regulation on competitive conditions in the Iranian banking industry for the period 1996-2006. The time interval under examination corresponds to an era characterized by substantial relaxation of entry barriers and private bank penetration. To estimate Lerner indexes as a measure of bank competition, we set up a simultaneous equation model for unbalanced panel data by utilizing the stepwise maximum likelihood method. We find that concomitantly with the new bank entries a pro-competitive change in the banking industry took place.

Statistical tests based on newly collected cross-sectional data suggest that countries which have more first-tier subnational governments relative to their population are more corrupt. I measure the strength of association between “corruption” and the variables “population per regional government” and “average area of first-tier unit,” both individually and combined as the interaction effect “size decentralization,” in 100 randomly selected countries. Two theoretical arguments may explain these associations: (i) the greater the quantity of first-tier subnational units with monopolistic powers, such as legal and regulatory sanctions, the greater the incentives for bribery and extortion; and (ii) elected authorities and public servants of smaller regional governments are more vulnerable to capture by a corrupt private elite, especially when control and accountability mechanisms are weaker than national ones. This paper also provides some support for existing corruption theories, namely that wealthy countries with Protestant societies use democratic systems more effectively to control corruption.

This paper demonstrates the sensitivity of the linear programming approach in the estimation of productivity measures in the primal framework. Specifically, the sensitivity to the number of constraints (level of dis-aggregation) and imposition of returns to scale constraints is evaluated. Further, the shadow or dual values are recovered from the linear program and compared to the market prices used in the ideal Fisher index approach. Empirical application to U.S. state-level time series data from 1960-2004 reveal productivity change decreases with increases in the number of constraints. Divergence in productivity measures is observed due to the choice of method imposed, various levels of commodity/input aggregation, and technology assumptions. Due to the piecewise linear approximation of the nonparametric programming approach, the shadow share-weights are skewed leading to the difference in the productivity measures due to aggregation.

As Ronald Coase points out, there are two kinds of conceptions of economics: first, the conception that emphasizes the study of specific kinds of human activities; and, second, the conception that makes economics the study of a specific approach to all human choices. The paper first shortly reviews the two conceptions. Then, it links them to specific conceptions about rationality. An analysis of the terms involved in the discussion shows which conception of economics corresponds most to its ordinary language meaning. The paper then analyzes and develops Coase’s argument for the first and against the second conception, explores the limits of an integration of the two views and assigns them specific roles.

Public procurement is a dynamic process involving vendors, contractors and procuring agencies. Even before submitting bids, competition among contractors may already have started. Given the nature of public work and expected strategies of rivals, some firms decide to enter the market, but others do not. Procurers can also enhance or limit the bidder participation through various ex ante qualification procedures for quality assurance purposes. Some applicants are qualified, but others are not. Thus, the selection process has two dimensions: bidders self-select, and an auctioneer may (dis)qualify some applicants. The paper explores this selection dynamics, using procurement data from road projects in developing countries. It shows that bidders are selecting themselves; low-cost firms are more prone to enter the market. But they are more likely to be rejected for technical reasons. Procurement design, such as contract size, and public governance are also found important determinants of the entry strategy of firms.

This paper studies the characteristics of credit card holders in Malaysia and distinguishes between convenience users and revolvers. A Tobit model with binary selection and ordinal treatment is developed to accommodate the data feature that debts are incurred only among card holders and the endogeneity of card holding in card debt. Results from a stratified sample in Malaysia indicate that age, household size, income, education, loan commitments, and current-account ownership play a role in card holding. Age, loan commitments, previous card holdings, current-account ownership, and bad debt history affect the probability and level of card debt. Multi-card holders are more likely to be credit revolvers than convenience users.

The goal of this paper is to provide a better understanding of monetary policy effectiveness in the case of indexed bonds. When public debt management deals with bonds indexed to the interest rate set by the monetary policy, there is no wealth effect and, as a consequence, monetary policy has a weak transmission channel reducing its effectiveness. This can help to explain why monetary policy in Brazil has been so tight and interest rates so high during the Real Plan.

On the nonlinear causality between inflation and inflation uncertainty in the G3 countries (pp. 269-296)

This study examines the dynamic relationship between monthly inflation and inflation uncertainty in Japan, the US and the UK by employing linear and nonlinear Granger causality tests for the 1957:01-2006:10 period. Using a generalised autoregressive conditional heteroskedasticity (GARCH) model to generate a measure of inflation uncertainty, the empirical evidence from the linear and nonlinear Granger causality tests indicate a bidirectional causality between the series. The estimates from both the linear vector autoregressive (VAR) and nonparametric regression models show that higher inflation rates lead to greater inflation uncertainty for all countries as predicted by Friedman (1977). Although VAR estimates imply no significant impact, except for Japan, nonparametric estimates show that inflation uncertainty raises average inflation in all countries, as suggested by Cukierman and Meltzer (1986). Thus, inflation and inflation uncertainty have a positive predictive content for each other, supporting the Friedman and Cukierman-Meltzer hypotheses, respectively.

Financing availability and investment decisions of Slovenian farms during the transition to a market economy (pp. 297-317)

This paper investigates the financial determinants of investment decisions made by Slovenian family farms during the transition to a market economy in the period 1994-2003. Results from standard and augmented accelerator models indicate that farms’ investment decisions were based on market opportunities during this period, ruling out the presence of soft budget constraints, but that these decisions were constrained by the availability of finance. Further analyses reveal a non-significant impact of investment subsidies received by farms, but a positive impact of operational subsidies for small farms only, on the alleviation of financial constraints.

James L. ButkiewiczUniversity of DelawareHalit YanikkayaGebze Institute of Technology

Institutions and the impact of government spending on growth (pp. 319-341)

This paper reports the results of a study of the impact of government expenditures on economic growth, emphasizing how government effectiveness influences the efficiency of government spending. The effects of sub-categories of government spending on growth are also examined. Total expenditures are estimated to have negative growth effects for some groupings of developed nations. Consumption expenditures are found to have a detrimental growth effect in developing nations with ineffective governments. Developing nations with ineffective governments benefit from capital expenditures. To stimulate growth, developing nations should limit their governments’ consumption spending and invest in infrastructure.

We conduct an empirical application based on Coe and Helpman’s (1995) seminal work, in order to measure the elasticity of technical progress with respect to R&D capital for the G5 countries between 1971 and 2003. For this purpose, a series for technological capital is built for the 1990-2003 period, and linked with Coe and Helpman’s series for the 1971-1990 period. The technical progress of leading countries depends critically on the domestic R&D capital stock, in line with Coe and Helpman’s (1995) and Coe, Helpman and Hofmaister’s (2009) work. Nevertheless, there are some important differences. The estimations for the elasticity values appear to be higher and show larger differences between countries than in previous studies. Furthermore, the results give evidence in favour of Schumpeterian models, as TFP growth is positively related to the distance to the technological frontier represented by the US.

This paper presents a method of predicting individuals’ welfare changes (compensating and equivalent variations) arising from a tax or social security policy change in the context of behavioural microsimulation modelling, where individuals can choose between a limited number of discrete hours of work. The method allows fully for the nonlinearity of the budget constraint facing each individual, the probabilistic nature of the labour supply model and the presence of unobserved heterogeneity in the estimation of preference functions. Yet it is relatively straightforward to implement. An advantage of welfare measures, compared with changes in net incomes, is that they take into account the value of leisure and home production. The method is applied to a hypothetical income tax policy change in Australia.

Quantifying the effects of job matching through social networks (pp. 35-59)

The recent literature explains the theoretical implications of the matching of workers to jobs through social networks. These insights are obtained for extremely simplified economies or rely on unrealistically simple social networks. Therefore, it is difficult to obtain a sense for the quantitative importance of effects generated by real life social networks. In this paper, I augment a labor market matching model to allow for information transmission through social networks. I illustrate the effects of social networks and I use simulations to quantify the predictions of the model for complex and realistic social networks. Information transmission through social contacts reduces the steady state unemployment rate from a hypothetical 6.5% to 5%. Social referrals can explain 1/5th of the observed duration dependence of unemployment. They cannot explain much of the variation in wages of otherwise homogeneous workers and do not substantially influence aggregate outcomes over the business cycle.

Venezuelas growth experience over the 56-year period from 1950 to 2006 was characterized by a high economic growth rate from 1950 to 1974 and a low economic growth rate from 1974 to 2006. We show that the country has been immersed in a great depression since the mid-seventies. We also show that although Venezuela is an oil abundant economy, this growth experience is largely due to the evolution of its non-oil GDP. We perform a growth accounting exercise to quantify the extent to which the growth experience in the non-oil sector is a result of physical capital accumulation, finding that non-oil sector behavior can largely be explained by the evolution of total factor productivity (TFP). Finally, we calculate the correlations between oil rents and physical capital accumulation and TFP in the non-oil sector, finding a high positive correlation during the good performance period, but a negative correlation in the implosion period.

This paper aims at analysing the dynamic properties of real wages over the business cycle. We apply a Bayesian vector autoregressive (BVAR) model and analyse the possible asymmetric behaviour of real wages in response to different macroeconomic shocks. Finally, we use the NBER business cycle periodisation to evaluate how real wages interact with the different shocks during contractions and booms. The results indicate that real wages cyclicality substantially depends on the driving forces of business cycle fluctuations. Different time periods are dominated by different types of shocks. When the business cycle is mainly driven by supply-side shocks real wages present a pro-cyclical behaviour. On the contrary, when the business cycle is driven by aggregate demand shocks real wages move counter-cyclically.

This article examines the real convergence hypothesis in OPEC countries (Algeria, Angola, Ecuador, Gabon, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates and Venezuela) using time series techniques and allowing for structural breaks. The main results show lack of support for income convergence in OPEC countries. We only find evidence of catch-up with the U.S. economy for the case of Indonesia, and for Angola in the last years of the sample. These findings are in line with the resource curse literature, which suggests that natural resource dependence inhibits economic growth. Furthermore, the results suggest that the countrys oil export dependence is negatively related with its per capita GDP growth rate.

It is well documented that since the mid-1980s there has been a surge in capital flows due to an increased integration of world financial markets. Absent limited commitment, the increase in financial linkages should improve risk-sharing opportunities and foster consumption smoothing. However the data show that for several countries financial liberalization leads to enhanced consump tion volatility. This fact can be rationalized using a small open economy model where foreign lending to households is constrained by a borrowing limit motivated by limited enforcement. Borrowing is secured by collateral in the form of durable investment whose accumulation is subject to adjustment costs. In this economy an increase in the degree of capital account lib eralization increases consumption volatility (even relative to output volatility) as agents are unable to exploit risk-sharing opportunities. In presence of riskaverse agents an increase in financial integration reduces welfare.

This paper utilizes the geometric techniques developed in Khan and Mitra (2005, 2007) to analyze the optimal intertemporal allocation of water resources in a dynamic setup without discounting. The framework features two sectors: the first uses labor to purify water, while the second uses labor and purified water for irrigation to produce an agricultural consumption good. Purified water can also be used as potable water for drinking purposes. The planner allocates the available factors of production between the two sectors every period, and determines the optimal amounts of purified water, potable water, and irrigation water. The geometry characterizes the optimal path depending on whether the irrigation sector is more labor intensive than the purification sector. When the irrigation sector is labor intensive, the optimal path is a non converging cycle around the golden rule stock of purified water, while if the purification sector is labor intensive, there is a damped cyclical convergence to the go lden rule stock.

We argue that, theoretically, exchange rate pass-through (ERPT) into consumer prices may be nonlinear in contrast to standard linear estimates found in the literature. ERPT can be higher in periods of financial or confidence crises, when firms have no incentive to absorb cost increases in their margins. We test this hypothesis applying a logistic smooth transition (LSTR) model to Mexican data. Using two different measures of macroeconomic instability as transition variables, we find that ERPT does seem to increase in periods of macroeconomic distress, which highlights the importance of a stable macroeconomic environment in reducing ERPT in emerging markets.

The increasing interest in multidimensional poverty and well-being analysis has added complexity to the way these phenomena are conceptualized and measured. When multiple attributes are considered, a criterion determining the relative importance attached to the different dimensions has to be adopted. There has not been thus far in the literature a specific attempt to conceptualize the nature of the desired hierarchy among the selected poverty dimensions. The aim of this paper is to take the first step in this direction. We envisage two simple and highly intuitive ways in which such a hierarchical system can be understood, which we label restricted and unrestricted hierarchy. The analytical conditions allowing the incorporation of these into a poverty index are derived and their implications in terms of the understanding of poverty are discussed. An empirical application shows how the choice of the hierarchical scheme for poverty dimensions can lead to opposite conclusions on the poverty trend.

In this paper, we study the impact of fiscal rules, in the form of explicit deficit or debt constraints, on fiscal policy volatility. The main motivation behind this research is, on the one hand, a negative and robust correlation of fiscal policy volatility and long run growth documented in several papers and, on the other, the relatively small number of works that discuss possible determinants of the former. We argue that fiscal rules have a significant impact on fiscal policy volatility, but depending on the target of the rule public debt or fiscal balance rules will increase or decrease policy volatility. This result is novel, and, to the best of our knowledge, has not been discussed in the literature.

José Ignacio AntónUniversity of SalamancaRafael Muñoz de BustilloUniversity of SalamancaMiguel CarreraUniversity of Salamanca

Labor market performance of Latin American and Caribbean immigrants in Spain (pp. 233-261)

This paper analyzes the wage differentials in Spain between local and foreign employees from Latin America and the Caribbean. It also explores the earnings gap between Latin American employees and other groups of foreign workers from both developing and developed countries. The study is based on the Wage Structure Survey 2006, which is the first nationally representative sample of both foreign and Spanish employees. Using the Machado-Mata econometric procedure, earnings differentials across the whole wage distribution are decomposed into a component related to observable characteristics and another associated to different returns to such endowments. First, we find that, in absolute terms, the earnings differential between Latin American and Caribbean immigrants and natives that is not explained by observable characteristics increases across the wage distribution. While the large gap at the top might be mainly explained by problems of transferability of skills among immigrants, the low differential at the bottom is likely to be related to the compressive effect exerted by labor market institutions such as the minimum wage and collective agreements. A quite similar pattern is observed when they are compared with developed countries´ workers. Secondly, there does not seem to be a significant wage gap between Latin American and the rest of foreign employees from developing countries, possibly because immigrants are largely employed in low-skill jobs where Spanish proficiency is not an essential asset.

On the sustainability of government deficits: Some long-term evidence for Spain, 1850-2000 (pp. 263-281)

We provide a test of the sustainability of the Spanish government deficit over the period 1850-2000, from the estimation of a cointegration relationship between government expenditures and revenues derived from the intertemporal budget constraint. The longer than usual span of the data allows us to obtain more robust results on the fulfilment of the intertemporal budget constraint than most of the previous analyses. Two additional robustness checks are provided. First, we investigate the possibility of structural changes occurring along the period analyzed, using the new approach of Kejriwal and Perron (2008, 2010) to testing for multiple structural changes in cointegrated regression models. Second, we investigate whether the behaviour of fiscal authorities has been non-linear, by means of the procedure of Hansen and Seo (2002) based on a threshold cointegration model. Our results show that (i) the government deficit has been strongly sustainable in the long run, (ii) no evidence is found on any significant structural break throughout the whole period, and (iii) fiscal sustainability has been attained due to the non-linear behaviour of fiscal authorities, which have only acted on the budget deficit when it has exceeded around 4.5% of GDP.

Pollution havens have received a great deal of attention in the past 15 years. However, the literature has focused almost exclusively on production side externalities and whether dirty industry migrates to countries with lax environmental laws. More recently, concerns have been raised about the rapid explosion of consumption side pollution such as e-waste and its trade in international markets. Between 1996 and 2007, US exports of waste plastics and ferrous waste along the USA-Asia trade route increased by 917% and 482%, respectively. Over the same time period the average freight rate on commercial liners along the USAAsia trade route fell by 46%, while average freight rates along the Asia-USA trade route increased by 2.9%. This paper develops a two country trade model with endogenous asymmetric transport costs as well as externalities associated with harmful waste generated from consumption. It shows that even when both governments set optimal Pigouvian taxes on the consumption of the dirty good, endogenous asymmetric transport costs can lower the backhaul rate from North to South. This creates an environmental arbitrage condition by which it is cheaper for the North to export its waste to the South rather than dispose of it at home. The model yields a number of clear predictions regarding the relationship between country characteristics, the international terms of trade, the backhaul shipping rate, and the Norths export supply function of waste.

Who wins in South-South trade agreements? New evidence for MERCOSUR (pp. 305-334)

Using a detailed database on intra-MERCOSUR tariffs, we estimate the effect of tariff preferences on the origin of imports of MERCOSUR members. The results show tariff preferences affected imports patterns in the cases of Argentina and Uruguay, and to a less extent also those of Brazil. For the first two countries the results support the hypothesis that MERCOSUR has produced a diversion of trade, no similar evidence is found for Brazil and Paraguay.

Income mobility and economic inequality from a regional perspective (pp. 335-350)

A necessary condition for mobility to reduce the popular desire for redistribution is a significant positive correlation between inequality and mobility. In Prieto et al. (2008), a significant positive relationship was found at the national level. The objective of this study is to establish empirically whether such a relationship is maintained at the regional level. The indices are calculated for the set of EU regions using the European Community Household Panel survey. Total mobility is decomposed into three terms: growth, dispersion and exchange. We show that this positive relationship is robust by estimating a hierarchical linear model.

David W. GalensonUniversity of Chicago and National Bureau of Economic Research

Understanding Creativity (pp. 351-362)

The discipline of economics has traditionally refused to study the behavior and achievements of specific individuals. Yet creativity  a primary source of the technological change that drives economic growth  is largely the domain of extraordinary individuals or small groups. For the first time in the history of the discipline, within the last decade economists have begun to study how these extraordinary individuals make their discoveries, and the results have been dramatic. Research done to date has demonstrated that artistic innovators can usefully be divided into two types. Experimental innovators seek to record their perceptions. They proceed tentatively, by trial and error, building their skills gradually, and making their greatest contributions late in their lives. In contrast, conceptual innovators use their art to express ideas and emotions. The precision of their goals allows them to plan their work, and execute it decisively. Their most radical new ideas, and consequently their greatest innovations, occur early in their careers. The research that has established these patterns has several central components. A key element is the systematic measurement of an artists creativity over the course of the life cycle: this not only establishes when the artist made his greatest contribution, but also provides an objective identification of his greatest innovation. This facilitates another key element of the research, the categorization of the artist as experimental or conceptual. This effectively depends on whether the artist works inductively, building his contribution incrementally from observation, or deductively, creating his innovation as a consequence of a new idea. These patterns have been established empirically, by a large number of studies of important practitioners of a wide range of arts. It is now time to extend economic research on creativity, by applying this analysis to other intellectual domains. It is important to recognize that economists failure to study individuals has prevented them from understanding the sources of the contributions of the most productive people in our society. Breaking this disciplinary taboo may now allow us not only to understand, but perhaps also to increase, the creativity of these remarkable individuals, and to help others to follow them.

Publication and citation rankings have become major indicators of the scientific worth of universities and determine to a large extent the career of individual scholars. Such rankings do not effectively measure research quality, which should be the essence of any evaluation. These quantity rankings are not objective; two citation rankings, based on different samples, produce entirely different results. For that reason, an alternative ranking is developed as a quality indicator, based on membership on academic editorial boards of professional journals. It turns out that the ranking of individual scholars based on that measure is far from objective. Furthermore, the results differ markedly, depending on whether research quantity or quality is considered. Thus, career decisions based on rankings are dominated by chance and do not reflect research quality. We suggest that evaluations should rely on multiple criteria. Public management should return to approved methods such as engaging independent experts who in turn provide measurements of research quality for their research communities.

This paper assesses the presence of seasonal volatility in price indexes where a similar type of pattern has been reported in asset prices in financial markets. The empirical evidence from Turkey for the monthly period from 1987:01 to 2007:05 suggests the presence of seasonality in the conditional variance of inflation. Thus, inferences for the models that do not account for the seasonality in the conditional variance will be misleading.

This paper examines economic, sociocultural, and behavioral risk factors that influence the compensating price difference (premium paid) between sex with and without a condom for female sex workers (FSWs) in U.S.-Mexico border cities. Field data collected in Ciudad Juarez on the price of sex with and without a condom for the same FSW respondent allowed calculation of the price premium for unprotected sex based on these paired prices, holding unobservable characteristics constant. A Tobit model was used to identify the factors determining the price premium. Key predictors of a larger price premium for sex without a condom included: length of time as a FSW; number of male clients; and participation in HIV education. Key predictors of a decrease in the price premium for unprotected sex included: age; a bad financial situation; frequent alcohol consumption before or during sex; and frequent drug use before or during sex.

Regulation of entry and the distortion of industrial organization (pp. 91-111)

We study the distortions of industrial organization caused by entry regulation. We take advantage of heterogeneity across industries in their natural barriers and growth opportunities to examine whether industries are differentially affected in countries according to entry regulation. First, we consider the effect of entry regulation on the (static) industry structure. We find that regulation has a greater impact in industries with lower natural barriers to entry, both on the number of firms and on the average size of firms. We find that the effect of entry regulation on industry share is not related to differences in natural barriers. Regarding industry dynamics, we find that in countries with high entry regulation, industries respond to growth opportunities through the expansion of existing firms, while in countries with low entry regulation, growth opportunities lead to the creation of new firms; finally, the total sectoral response is invariant to the level of regulation.

Income inequality and the suicide rate in Japan: Evidence from cointegration and LA-VAR (pp. 113-133)

Using time series techniques, this paper examines the relationship between the suicide rate and income inequality in Japan. Since both the suicide rate and income inequality (Gini coefficient) in Japan are integrated of order one for the sample period 19512007, the existence of cointegration is a prerequisite for the successful modeling of their relationship. The Durbin-Hausman test shows that the suicide rate is cointegrated with income inequality and the unemployment rate. The dynamic ordinary least squares (DOLS) and fully modified ordinary least squares (FMOLS) methods demonstrate that income inequality and the unemployment rate are positively and significantly related to the suicide rate in Japan, and there is evidence supporting the parameter stability of our suicide model. Furthermore, the lag-augmented vector autoregression (LA-VAR) approach shows that there exists unidirectional Grangercausality from income inequality to the suicide rate. Hence, the fluctuations in Japans suicide rate are partially explained by income inequality.

Demand shocks and the cyclical behavior of the real wage: Some international evidence (pp. 135-158)

The focus of this investigation is on the cyclical response of the real wage to demand shocks. This response differentiates the empirical validity of major New Keynesian explanations of business cycles. The empirical evidence, across industrial countries, highlights a moderate positive correlation between nominal wage and price flexibility in response to various demand shocks. Nonetheless, higher price flexibility moderates the effect of demand shocks on real output, while higher nominal wage flexibility increases, or does not determine, the effects of demand shocks on real output across countries. An increase in the response of the real wage to demand shocks therefore exacerbates their real effect on output, as predicted by sticky-price models. Further, demand shocks do not determine the difference in wage variability. Nominal wage variability increases, in turn, output variability across countries. In contrast, demand shocks differentiate price variability. Price variability moderates, in turn, output variability across countries.

This paper evaluates the empirical validity of the New Keynesian Phillips Curve (NKPC) model of rational expectations. We employ an instrumental variable (IV) projection method to approximate inflation expectations, and show that the inference based on this approach can differ significantly from the one based on rational expectations. More importantly, using an IV test for serial correlation in the GMM context, we find that the error term in the stylized NKPC model is significantly serially correlated. To compensate for the serial correlation problem, we propose an extended framework which can be easily rationalized in terms of sticky price setting of backward-looking firms. Empirical results show that further lags of inflation are needed in the hybrid specification of the NKPC in order to rule out serial correlation in the Euler equation.

Labor informality bias of a poverty-alleviation program in Argentina (pp. 181-205)

In 2002, in the midst of a serious macroeconomic crisis, Argentina implemented a large social program (the Programa Jefes de Hogar, PJH) that provides cash transfers to unemployed household heads meeting certain criteria. In practice, the difficulty in monitoring the unemployment requirement for informal (unregistered) workers would imply a disincentive for the program participants to search for a formal job. By applying matching techniques we evaluate the empirical relevance of this prediction during the period of strong economic growth that followed the crisis. We find some evidence on the informality bias of the PJH when the value of the cash transfer was relatively high compared to wages in the formal labor market.

The choice of policy instruments to control pollution under costly enforcement and incomplete information (pp. 207-227)

We analyze the cost of enforcing a system of firm specific emissions standards vis a vis a transferable emissions permit system in the context of complete and incomplete information. We also examine the optimality of a transferable emissions permit system when abatement costs and enforcement costs are considered. We show that under incomplete information, regulation based on each firm-specific emissions standards cannot be less costly than a transferable emissions permit system. In addition, we find that the distribution of emissions that minimize aggregate program costs differ from the distribution of emissions generated by a competitive transferable emissions permit system.

Juncal CuñadoUniversidad de NavarraLuis Gil-AlanaUniversidad de NavarraFernando Pérez de GraciaUniversidad de Navarra

New evidence on long-run monetary neutrality (pp. 229-248)

This paper re-examines the issue of long-run monetary neutrality by using fractional integration and allowing for a possible structural break in six countries: the United States, the United Kingdom, Mexico, Brazil, Australia and Argentina. We use an extension of Fisher and Seaters (1993) reduced-form test recently proposed by Bae, Jensen and Murdock (2005). The results show that long-run monetary neutrality holds for five countries when no structural breaks

Previous studies have recognized that the benefits from foreign direct investment (FDI) to recipient countries can only be realized when those countries have reached a certain level of financial development. However, the dynamic interrelationships among FDI, financial development, and real output, including the long-run equilibrium as well as causality, have not been analyzed. This paper overcomes this major shortcoming by applying recent advances in panel cointegration and panel error correction models for a set of 37 countries using annual data for the period 1970-2002. For the first time, we explore the directions of causality among FDI, financial development, and economic growth and obtain solid, convincing evidence of a fairly strong long-run relationship. Furthermore, the financial development indicators have a larger effect on economic growth than does FDI. From the panel causality tests, while the evidence of a short-run relationship is weak, that of a long-run relationship among the variables is unequivocal. Overall, the findings underscore the potential gains associated with FDI when coupled with financial development in an increasingly global economy.

This paper studies the determinants of emerging market spreads, and thus of the cost of borrowing for emerging market sovereigns, using recent data from JP Morgans EMBI+ index for a panel of 19 countries. Controlling for traditional spread determinants, we focus on three additional factors whose importance is suggested by recent work: external shocks, the balance sheet effect of real devaluations, and the degree of current account leverage. We find clear and strong evidence that the variables in the foregoing categories have an economically and statistically significant relationship with spreads. In particular, we find a major role for the terms-of-trade volatility and the level of current account leverage in explaining spread variation. The result on current account leverage establishes an important link between a factor shown to make countries more vulnerable to sudden stops of capital flows, and the premium required by international investors on their foreign debt.

The benefits and problems of linking micro and macromodels - Evidence from a flat tax analysis (pp. 301-329)

Microsimulation (MS) and Computable General Equilibrium models (CGE) have both been widely used in policy analysis. Their combination allows the utilisation of the advantages of both types. The aim of this paper is to describe the state-of-the-art in simulation analysis and to illustrate the benefits and problems of linking micro and macro models by analysing flat tax reform proposals for Germany. Taking feedback effects into account has important implications for the evaluation of tax reforms. The analysis shows that a personal income flat tax can indeed overcome the fundamental equity efficiency trade-off while simultaneously increasing the tax revenue. However, this result does not hold for a flat tax combining a personal income flat tax with a corporate cash flow flat tax, even when allowing for an expost loss in revenue, as the top of the distribution still gains the most.

I examine the role of reputation in a multi-stage strategic information transmission game between an analyst and an investor. While reputation mitigates the conflict of interest in a repeated game, it may induce the biased analyst to elevate potential underperformers to the highest rating category, thus undermining the information quality of the highest message. Uncertainty about firm value helps the unbiased analyst to communicate better information in a single stage game. However, in a multi-stage game, uncertainty increases misrepresentation by the biased analyst. Empirical implications are tested. I document that 1) affiliated and unaffiliated analysts recommendations differ only in the Strong Buy category; 2) the underperformance of underwriter analysts recommendations increases with the underlying uncertainty.

David GalensonUniversity of Chicago and National Bureau of Economic Research

Old masters and young geniuses: The two life cycles of human creativity (pp. 1-9)

There are two fundamentally different approaches to innovation, and each is associated with a distinct pattern of discovery over the life cycle. Experimental innovators work by trial an error, and arrive at their major contributions gradually, late in life. Conceptual innovators make sudden breakthroughs, usually at an early age. Both types of innovators have made important contributions to art and science.

Christos AgiakloglouUniversity of PiraeusSotiris KarkalakosKeele University and University of Illinois at Urbana-Champaign

A spatial and economic analysis for telecommunications: Evidence from the European Union (pp. 11-32)

This paper evaluates the role of a number of determinants of telecommunication services in the European Union. We use a logistic model with spatial covariates to estimate the demand function for telecommunications in the Union. Our results show that different types of interconnections generate diverse estimates for country specific demand. The impact on telecommunications from countries with spatial, economic or social similarities differs based on those characteristics. Omitted variable bias from not modeling spatial interdependence is limited in models under spatial connectivity criteria. This satisfies the statistical inference drawn by previous empirical studies regarding determinants of telecommunications.

On the purchasing power parity for Latin-American countries (pp. 33-54)

This paper tests the hypothesis of long-run purchasing power parity (PPP) for all Latin American countries. Those countries share characteristics as high inflation, nominal shocks, and trade openness which might have led to quicker adjustment in relative prices and contributed for PPP to hold. New time series unit root tests give evidence of stationary real exchange rates for the vast majority of countries. In the panel data framework, tests for the null of unit root, null of stationarity, and unit root under multiple structural breaks indicate that the pooled real exchange rate is stationary. Thus, the results provide convincing evidence that PPP holds in Latin-America in the post-1980 period.

The contribution of government transfer programs to inequality. A net-benefit approach (pp. 55-67)

The contribution of government transfer programs to inequality is often assessed by analyzing to what extent the benefits paid go to lower income families. Several analysts have found that some key government transfers actually go mostly to middle and high income families and thus contribute to greater inequality. We argue in this paper that the impact of these programs on inequality should be evaluated considering the benefits received net of the taxes paid by households to finance the programs, since higher income households receive higher benefits but they also pay higher taxes. We illustrate this approach by estimating the impact of three government programs on inequality in Uruguay and show that the conclusions are different depending on whether we use gross or net benefits in the estimation.

A note on management efficiency and international banking. Some empirical panel evidence (pp. 69-81)

This analysis focuses on the assumption that management efficiency is one of the most important company-specific factors affecting a banks international activities. The theoretical results on whether good or bad management influences international activities in banking are mixed. We attempt to let the data speak for itself, applying advanced panel-econometric regression models to a dataset covering 747 universal banks based in Austria for the period running from 1995 to 2002. The dataset is unique in the sense that it provides almost full coverage of a banking sector at the company level that expanded foreign operations during the period covered on an unprecedented scale at the time. We find that management efficiency as measured by X-efficiency affects the degree of a banks international orientation positively. In addition, risk-based capital and international orientation in banking is positively related.

Wonjoon KimKorea Advanced Institute of Science and TechnologyJeong-Dong LeeSeoul National University

Measuring the role of technology-push and demand-pull in the dynamic development of the semiconductor industry: The case of the global DRAM marke (pp. 83-108)

This paper reexamines and resolves the long dispute over the source of technological innovation by suggesting an integrated technology-push and demand-pull model. We derive an equilibrium model within the framework of differentiated product analysis and explain the dynamic interaction between these two sources of innovation. Based on the empirical analysis of the global DRAM market, we show that the relative importance of technology-push and demandpull in technological innovation is described by an L-type curve which describes the phenomenon where technology-push is greater than demand-pull in the early stages and then decreases as demand-pull becomes greater. Our finding suggests that the role of supply and demand is different in inducing technological change and their relative importance changes with product development over the technological life cycle; the marginal prices of products are an important factor in determining the principal forces of technological innovation between these two source s.

The existing literature has dealt inadequately with the link between education and economic growth in developing countries, particularly for Africa which has experienced a massive growth of enrolment at all levels of education during the second half of the 20th century. Moreover, the issues of causality and dynamics have been largely ignored until lately. This paper investigates the empirical link between education and economic performance for the case of 40 African States for the time period 1980-2000 using both static and dynamic panel data analysis. Result from the analysis shows that education has been an instrumental element in the growth process, though to a lesser extent as compared to recent empirical works. The study also confirms the presence of dynamics in the education-growth debate and is in line with recent findings from other developing country cases.

Have liberalisation and NAFTA had a positive impact on Mexico´s output growth? (pp. 159-180)

This paper analyses the role of real exports, and foreign direct investment in explaining real growth in an era of economic liberalisation. The econometric approach is based on time series analysis using VARs, Granger causality, impulse response functions and variance decomposition. The empirical results reveal that exports Granger cause output growth in Mexico, which is a possible confirmation of the Export-led growth paradigm. However, no effect from FDI on GDP is found. The inclusion of NAFTAs potential impact confirms the positive effect of exports and reveals that GDP and exports Granger cause FDI. The evidence suggests that export promotion and liberalisation in Mexico had the potential to attract greater flows of foreign capital and induce economic growth.

This paper studies the nature of monetary policy in a cash-in-advance model with indivisible labor and with financial intermediaries that provide loans for working capital. Monetary policy occurs through money injections either directly to families or to financial intermediaries. Injections to families produce an inflation tax while injections directly to financial intermediaries provide an inflation subsidy that improves output, consumption, and welfare. This model helps explain why monetary policy based on growth in monetary aggregates can have ambiguous output effects, why central bankers usually prefer interest rate rules to monetary aggregate rules, and why estimated money demand equations tend to be unstable.

Giorgio Di PietroWestminster Business SchoolLucas PedaceDepartment of Work and Pensions

Changes in the returns to education in Argentina (pp. 259-279)

In this paper we examine the returns to education in Argentina from 1995 to 2003. We use several econometric techniques in an attempt to account for sample selection bias arising from endogenous labour force participation and to control for the endogeneity of education. The empirical results indicate that the returns to education have fluctuated over time. We provide some evidence suggesting that the relative demand for more educated people is likely to be a key factor in explaining changes in the returns to education.

We develop a new indicator of profit inefficiency, which is based on decision-makers choosing the amount to spend on each input and the amount to earn on each output, rather than choosing physical quantities of inputs and outputs. The method is suitable for situations when prices and quantities are not directly observable, when markets are non-competitive, or when qualitative differences exist for inputs and outputs between firms. The indicator of profit inefficiency equals normalized lost profits arising from technical inefficiency and allocative inefficiency. We offer an empirical example of our method using firms in the Japanese securities industry during the period 1989-2005. We find profit inefficiency rises from 1989 to 1993, declines during the 1994-2001 period, and then increases during the years 2002-2005. Allocative inefficiency tends to be a greater source of profit inefficiency than technical inefficiency. Lost profits as a percent of assets range from 0% to 15% and are highest in 2002-2005.

Assessing the sustainability of fiscal policies: Empirical evidence from the Euro Area and the United States (pp. 305-326)

This paper provides a formal theoretical framework for analyzing the sustainability of fiscal policy based on the government intertemporal budget constraint, and derives conditions that determine whether a fiscal stance is sustainable in the medium and long term. In contrast to previous studies, it uses a log-linearization of the public debt identity and generalizes the results obtained in the literature by using a multivariate test. The analysis is applied to the fiscal position of the United States and the Euro Area. On the basis of infinite horizon-tests the broad conclusion is that both regions have a sustainable fiscal policy.

The intertemporal approach to the current account: Evidence for Argentina (pp. 327-353)

The Argentinean current account has exhibited large fluctuations over time. Sizable deficits over the last part of the 19th century and beginning of the 20th were followed by an almost equilibrated balance for most of the 20th century. Moderate deficits were again recorded between 1990 and 2002. Can factors highlighted by the intertemporal approach to the current account explain the dynamics of the Argentinean external sector for the 1885-2002 period? To answer this question we make use of a model featuring two main external shocks for small economies: real interest rates and exchange rates. In contrast to its application to other Latin American countries, the intertemporal model does not track well the actual current account from 1885 to 2002 in Argentina. This is due to the country's lack of access to the international financial system (a main assumption in the model), the occurrence of balance of payments crises, and the stop and go process. There is, however, some evidence in favor of the theor y for the period 1885-1930, when capital mobility was relatively high and free of currency crises and stop and go cycles.

Long term contracts increase the hazard of ex post maladaptation, creating demand for processes that enable adaptation over the course of long-term exchange. Enabling adaptation, however, may diminish the effectiveness of the long-term contracts, designed as prima facie hold-up remedies. Following Joskow (1987), we attempt to empirically capture the positive relationship between physical asset specificity and the duration of long-term contracts between California electricity generators. In addition, following Masten and Crocker (1985), we try to measure the effect of legal provisions on contract duration and interpret them as efficient instruments for providing flexibility in long-term relationships. The more important the investment in relationship-specific assets, the longer the contractual duration. However, parties mitigate long-term contract inflexibility, based on ex ante bargained terms and conditions, with provisions that allow for contingent adaptation. Our empirical results provide support for the hypothesised relationships under different model specifications and alternative estimation techniques.

Several recent theories postulate why some countries were able to devise institutions conducive to long-run economic growth whereas others were not. Most of these consider various historical factors or geographic characteristics as important predeterminants. But which of these theories comes closest to the truth? This paper simultaneously considers several competing theories and empirically examines which ones provide the strongest explanations for contemporary institutions. I find that settler mortality rates are strongly associated with contemporary institutions even when controlling for other important historical factors, including ones from theories that do not emphasize geographic characteristics. However, Englebert's concept of state legitimacy does best at explaining institutional outcomes within sub-Saharan Africa.

This paper investigates the convergence between the prices of ADRs and Mexican traded shares using a sample of 21 dually listed shares. Since both markets have similar trading hours, standard arbitrage considerations should make persistent deviation from price parity rare. We use a STAR model, where the dynamics of convergence to price parity are influenced by the size of the deviation from price parity. Based on different tests, we select the ESTAR model. Deviations from price parity tend to die out quickly; for 14 out of 21 pairs it takes less than two days for the deviations from price parity to be reduced by half. The average half-life of a shock to price parity is 3.1 business days, while the median half-life is 1.1 business days. By allowing a non-linear adjustment process, the average half-life is reduced by more than 50% when compared to the standard linear arbitrage model. We find that several liquidity indicators are positively correlated to the speed of convergence to price parity.

This paper presents a political economy model of exchange rate policy. The theory is based on a common agency approach with rational expectations. Financial and exporter lobbies exert political pressures to influence the government's choice of exchange rate policy, before shocks to the economy are realized. The model shows that political pressures affect exchange rate policy and create an over-commitment to exchange rate stability. This helps to rationalize the empirical evidence on fear of large currency swings that characterizes exchange rate policy of many emerging market economies. Moreover, the model suggests that the effects of political pressures on the exchange rate are lower if the quality of institutions is higher. Empirical evidence for a large sample of emerging market economies is consistent with these findings.

Credit constraints in education: Evidence from international data (pp. 33-60)

This paper tests empirically the credit-constraints thesis by using cross-country data on secondary and higher-education enrolment rates. Contrary to some previous works in this direction, we find several pieces of evidence that support the importance of such a thesis. First, controlling for the effects of both economic development and educational inequality, we find that school enrolments are negatively correlated with income inequality and positively correlated with financial-market development. Second, these correlations are robust to the specific country-effects, the composition of the sample of countries, and the inclusion of public education expenditures. Finally, public education expenditures are significantly correlated with school enrolment ratios. Distinguishing developed countries from developing ones reveals that the effects of both social and material factors are larger in rich countries than in poor ones. Our estimation results also show that the way public expenditures are allocated across educational levels affects enrolment ratios in higher educational stages. Specifically, countries where expenditure allocations are biased in favour of the advanced stages of education at the expense of the basic levels also experience low enrolment ratios in the higher levels of education.

Fabia Aparecida de CarvalhoBanco Central do BrasilCyntia F. AzevedoBanco Central do Brasil and Columbia University

The incidence of reserve requirements in Brazil: Do bank stockholders share the burden? (pp. 61-90)

There is consensus in the economic literature that reserve requirements are a tax levied upon financial intermediation, yet the incidence of the tax remains controversial. In this paper, we test whether changes in reserve requirements in Brazil impact the stock returns of the Brazilian financial system distinctly from the rest of the economy. We show that Brazilian bank stock returns may have been affected by changes in reserve requirements on both time deposits and transaction accounts, which implies that the tax burden of required reserves has not been fully passed through to banks' borrowers or clients. Stock returns of non-financial firms may also have been affected by changes in reserve requirements, suggesting that in some cases, reserve requirements on time deposits and transaction accounts served as a non-neutral instrument of monetary or fiscal policy in Brazil.

A vast literature has focused on what causes businesses to move into informality and what is the impact of an enlarging informal sector on growth. This paper shows that the size of the informal economy also affects business cycle volatility. Informal businesses are usually small in size, which not only prevents them from achieving economies of scale and from operating with the right capital/labor mix, but also restricts their access to credit markets. Because firms operating informally lack access to credit markets to neutralize the cash flow squeeze arising during recessions, they are more exposed to fluctuations in economic activity and more likely to fail. Using a Generalized Method of Moments methodology, this paper shows that countries with larger informal economies tend to undergo increased volatility in output, investment and consumption over the business cycle.

In the new Keynesian model of endogenous stabilization governments have objectives with respect to macroeconomic performance, but are constrained by an augmented Phillips curve. Because they react more quickly to inflation shocks than private agents, governments can lean against the macroeconomic wind. We develop an econometric test of this characterization of the political-economic equilibrium. Applying this methodology to a variety of quadratic social welfare functions provides inferences about the functional form of stabilization preferences and about the formation of expectations.

This paper uses a static spatial banking model with a non-uniform wealth distribution to provide theoretical assessments for differences in banks' prices and locations across regions. It assumes imperfect information, where banks know more about individuals if they are "near" the bank and individuals incur in a cost proportional to this distance to show the viability of their projects to the bank. A free entry model is constructed to account for banks' tendency to concentrate in rich regions and to charge lower prices. Comparative statics exercises show the effect of changes in the monitoring technology and wealth dispersion.

SamuelsonÂ´s full duality and the use of directed acyclical graphs (pp. 167-191)

To date, mixed demand systems have been all but ignored in empirical work. A possible reason for the scarcity of such applications is that one needs to know a priori which prices and quantities are endogenous in the mixed demand system. By using a directed acyclical graph (DAG), causal relationships among price and quantity variables are identified giving rise to a causally identified mixed demand system. A statistical comparison is made of the traditional Rotterdam model, a synthetic demand system, which subsumes the traditional Rotterdam model, and a Rotterdam mixed demand system identified through the use of a DAG. In this analysis, the respective demand systems consist of five products: steak, ground beef, beef roasts, pork, and chicken.

Computing and testing a stable common currency for Mercosur countries (pp. 193-220)

This paper develops a stable common currency for mid-sized open monetary economies with incomplete markets in general and the Mercosur countries in particular. The proposed currency is constructed as a derivative of a dynamic portfolio of securities that proxies the nominal exchange risk factors for a set of monies and floats against the rest of the world's currencies. We find that the resulting optimal common currency is comprised of currencies with country weights that are statistically significant and fairly symmetrical with relatively equal weight (e.g., 22% Argentinean pesos, 27% Brazilian reals, 27% Chilean pesos, and 23% Uruguayan pesos). We also find that increasing the number of countries in a common currency tends to increase its stability. The willingness of Mercosur countries to participate in a monetary union is assessed from statistical moments of the density functions of the implied stable common currency and its components.

Using the U.S. National Aeronautics and Space Administration (NASA) as a case study, this paper examines how conflicting objectives in procurement policies by public space agencies result in anti-competitive procurement. Globally, public sectors have actively encouraged mergers and acquisitions of major contractors at the national level, since the end of the "Cold War", following largely from the perceived benefits of economies of size. The paper examines the impact the resulting industrial concentration has on the ability of space agencies to follow a pro-competitive procurement policy. Using time series econometric analysis, the paper shows that NASA's pro-competitive policy is unsuccessful due to a shift, since the mid-1990s, in the share of appropriations in favour of its top contractors.

Macroeconomics and life satisfaction: Revisiting the "misery index" (pp. 237-251)

Using data from surveys of life satisfaction, evidence has been presented that European citizens' subjective well-being is inversely related to inflation and unemployment. Motivated by the "Barro Misery Index", this paper reconsiders the relationship between macroeconomics and subjective well-being by including the growth rate and the long-term interest rate as additional variables in life satisfaction regressions. The paper finds that people care about growth and employment on the one hand and stability on the other, where stability may alternatively be captured by the inflation rate or the long-term interest rate. Stability, measured in whichever of these ways, does not seem to be less important to European citizens than growth and employment.

The shadow economy in Portugal: An analysis with the MIMIC approach (pp. 253-277)

The paper estimates the Portuguese Shadow Economy (SE) from 1977 to 2004 and tests the statistical relationships between the SE and other economic variables. In order to carry out the econometric analysis, a multiple indicators multiple causes (MIMIC) model with means and intercepts is applied. The main causes of the Portuguese SE are analyzed and economic policies to reduce it are suggested. An appraisal on the reliability of estimates and an alternative benchmark strategy for the MIMIC approach are proposed.

In the 1990s globalization brought to most countries in Latin America unprecedented challenges for policymakers. This paper examines the interaction between the changing economic environment and the response of policymakers to the volatility experienced by international capital markets. In doing so, a number of lessons regarding the design of economic policy, and in particular fiscal policy are presented. The analysis focuses on issues such as fiscal sustainability in the presence of liquidity constraints, debt management strategies in emerging markets, the design of policy in response to sudden stops in capital flows, and the role of the International Monetary Fund.

This paper studies the detrimental effect of sudden stops on the growth of Thai firms' fixed assets. We focus on the fixed assets adjustment that firms undertake at times of financial constraints. We derive our results from balance sheet data for 284 nonfinancial Thai listed firms. Our data demonstrate that Thai firms faced severe declines in the growth of their fixed assets starting in 1996. Regression results demonstrate, after controlling for firms' characteristics and lagged dependent variables, that a longer-term debt maturity structure is the factor that works in the firms' favor during sudden stop episodes, while it is their profitability that matters during tranquil periods.

Sensitivity of international blocsÂ´ trade effect to alternative specifications of the gravity equation (pp. 337-360)

There are so many versions of the gravity model in the international trade literature that their results on trade effects inevitably vary even for the same international blocs. This paper evaluates these alternative specifications, and compares the resulting trade effects. The results show that there is considerable sensitivity to the specification of the gravity model used. Therefore, it is important to use the proper specification to accurately measure the trade effects. This paper suggests that removing restrictions on the parameters of the model with the introduction of year, exporter, importer, and bilateral effects is necessary to properly specify the model. In particular, factors included in the augmented model, especially monetary and spatial variables, are significant. An analysis of the resulting model also shows that international blocs effect on trade vary across blocs by the level of integration, the degree of their implementation, and their sectoral coverage.

Costly monitoring may lead to credit rationing in equilibrium in an economy without any adverse selection or moral hazard problems. Given the widespread phenomenon of government intervention in credit markets in developing and developed countries, the natural question then is, How effective are these government programs? I incorporate government loan programs in a simple, closed, pure exchange economy with borrowing and lending. Intermediation of funds is facilitated in credit markets characterized by a costly state verification problem. I then show that government loan programs (financed with lump-sum taxes) with co-financing can increase credit rationing when the private lender is the prior claimant in the event of a default. Moreover such programs unambiguously decrease the expected utility of both borrowers and lenders. On the other hand, when the government is the prior claimant, such programs decrease credit rationing and increase the expected utility of borrowers. Finally, with proportional repayments there is no effect on credit rationing or expected utility of agents.

This paper uses data from the General Household Survey to examine the economic returns to education between 1985 and 2003 for men and women in the UK. The evidence suggests that the returns to education have increased for men and declined for women. Quantile regression estimates illustrate that younger workers have come to experience more unequal returns to education across the conditional earnings distribution. The evidence suggests that both time spent in education and educational credentials are important in explaining earnings with higher qualifications always conveying higher earnings, holding years of schooling constant.

Geoffrey L. WallaceLa Follette School of Public Affairs, and Department of Economics, University of Wisconsin-Madison

Welfare flows and caseload dynamics (pp. 415-442)

Data from the 1990, 1991, 1992, 1993 and 1996 panels of the Survey of Income and Program Participations are used to estimate AFDC/TANF entry and exit rates. These estimates of AFDC/TANF entry and exit rates are used to conduct simulations aimed at determining the roles of economic conditions and welfare reform in explaining AFDC caseloads changes during the 1990s. The results of these simulations indicate that economic conditions were the engine driving the run-up in caseloads during the early 1990s and the decrease in caseloads following 1993.

We develop a simple human capital model for optimum schooling length when earnings are stochastic, and highlight the pivotal role of risk attitudes and the schooling gradient of earnings risk. We use Spanish data to document the gradient and to estimate individual response to earnings risk in deciding on attending university education, by measuring risk as the residual variance in regional earnings functions. We find that the basic response is negative but that in households with lower risk aversion, the response will be dampened substantially and may even be reversed to positive.

Mario CocciaNational Research Council of Italy and Max Planck Institute of Economics

A new taxonomy of country performance and risk based on economic and technological indicators (pp. 29-42)

This paper proposes a new taxonomy for countries based on principal component analysis. The paper investigates 51 countries using a set of 13 indicators of economic and technological performance for the period 2000-2002. The methodology reduces the variables and groups the countries that show similar strategic behaviour in the global market. The taxonomy facilitates the identification of country performance and risk, and provides relevant information both to international investors and to policy-makers, who must decide about global investment strategies and economic policies.

This paper uses a contract theory model to argue that covenants ruling debt renegotiations are important to assure the sovereign willingness to pay. The model includes the following features: first, collective action clauses, exit consents, aggregation provisions and pari passu clauses play an important role in the post default "game" of negotiations and coalitions. These covenants are represented in reduced form by the endogenous probability of refinancing a defaulted sovereign debt. Second, the model has "endogenous bad luck" because the unfavorable state of nature where default occurs depends on the level of indebtedness, which is itself an endogenous variable. Third, "vultures", contrary to conventional wisdom, tend to improve the access of emerging economies to capital markets because they might help to rule out strategic defaults. And fourth, under special assumptions the model is able to analyze the possibility of post default discrimination between domestic and foreign bondholders.

Regional and international market integration of a small open economy (pp. 77-98)

This paper studies the relationship between a set of commodity prices in a small open economy like Uruguay and the corresponding international and regional prices. The empirical methodology used is the multivariate cointegration procedure based on maximum likelihood methods introduced by Johansen (1988) as well as estimations of half-life persistence indicators. In the case of cereals, the evidence suggests strong market integration between domestic and regional markets and, to some extent, also to international markets. Therefore, directly or indirectly, domestic prices are connected with the efficient price signal. Results for beef indicate strong market integration between the domestic market and the regional market, which is not so well connected with international markets. Thus, domestic price appears to be linked to a regional price that is not linked to the efficient price signal.

Hany S. GuirguisManhattan CollegeChristos I. GiannikosColumbia University and City University of New York

A note on the effect of expected changes in monetary policy on long-term interest rates (pp. 99-114)

The ability of monetary policy to affect long-term interest rates is of central importance for economics and finance. Several recent studies have shown that long-term interest rates are virtually unaffected by monetary policy. This paper develops a statistical methodology to identify the expected and unexpected changes in monetary policy as measured by the federal funds rate. The empirical evidence shows that expected changes in the funds rate cause stronger and more significant movements in the long-term rates. Further, ignoring such asymmetry can erroneously generate the insignificant responses of long-term interest rates to the changes in the monetary policy.

Whether or not foreign direct investment helps to upgrade the technological capacities of firms in host countries is an important question for policy makers. Even more important is the question of what are the most effective channels of technology transfer. The econometric analysis presented here is based on a firm level database from Spain for the period 1990-2000. We associate spillovers with the effect of horizontal and vertical FDI on total factor productivity of local firms. We find that technology spillovers are limited to the case of vertical linkages. However these spillovers are affected by the technology gap between domestic firms and foreign affiliates as well as by the characteristics of foreign affiliates. Linkages with exportoriented affiliates and fully owned ones seem to have a better influence on the productivity of domestic firms.

Korea provides a unique opportunity to study the different behaviors or roles, if any, of limited flexibility and free floating exchange rate regimes. Korea shifted from a limited flexibility to a free floating exchange rate regime after the 1997 economic crisis. It is well documented that the exchange rate is very difficult to predict using any theoretical models for exchange rate determination. Based on a simple monetary model, we find that the impact of economic fundamentals on the exchange rate is very similar under both exchange rate regimes according to OLS estimates, but the difference is statistically significant with GARCH(1,1) results. We also find that the size of the exchange rate shock is much bigger under the free floating regime than under the limited flexibility regime. VAR results show that the exchange rate shock impact on inflation is not statistically different under the two regimes. These findings are generally in line with Baxter and Stockman (1989) for regime neutrality.

An estimation of residential water demand using co-integration and error correction tec hniques (pp. 161-184)

In this paper short- and long-run price elasticities of residential water demand are estimated using co-integration and error-correction methods. Unit root tests reveal that water use series and series of other variables affecting use are non-stationary. However, a long-run co-integrating relationship is found in the water demand model, which makes it possible to obtain a partial correction term and to estimate an error correction model. Using monthly time-series observations from Seville, Spain, we find that the price-elasticity of demand is estimated as around -0.1 in the short run and -0.5 in the long run. These results are robust to the use of different specifications.

Several papers have shown that high-inflation contributes to mean reversion in real exchange rates. This paper studies the Chilean peso (CLP) and Mexican peso (MXN) real exchange rates over 1980-2003. Three datasets are used: two with quarterly and monthly bilateral data (against the U.S. dollar) with consumer and producer price indices and another with monthly real effective rate exchange rates (REER). Unit root tests do not reject the root in levels for both currencies. Half-lives, however, contrast markedly: at 5 years or infinity for the Chilean peso and between 1 and 3 years for the Mexican peso. These findings suggest that the sharp depreciations in MXN and Mexico's relatively higher inflation record may have amplified monetary forces in the dynamics of the real exchange rates.

We investigate the impact on profit margins of exchange rate fluctuations in order to examine optimal pricing policy by source countries in the UK car market. We first estimate a nested logit demand model of new cars to calculate model-specific profit margins. Next we use these estimates to analyse the pricing-to-market (PTM) behaviour of car importers and local producers. The results show that: (1) profit margins fell over the period 1971-2002 as the UK car market moved from being a concentrated market to a looser oligopoly structure; (2) there is a positive association between exchange rate changes and mark-up adjustments of imported cars. Following a 10% pound depreciation, exporters' profit margins declined by up to 4% and local producers' profit margins increased by up to 2%; (3) PTM behaviour is asymmetric between appreciations and depreciations in bilateral exchange rates.

Changes in inequality and poverty in Latin America: Looking beyond income to health and education (pp. 215-234)

This paper uses Demographic and Health Survey data from six Latin American countries to analyze levels and trends of inequality for two important non-income measures of wellbeing, childrenz s stature and adult womenq s educational attainment. Our purpose is to determine whether the worrying trend of increasing income inequality in Latin America is also found in non-income dimensions of well-being. We find that it is not. Almost across the board, health inequality, measured by childreni s stature, and education inequality, measured by young womeni s years of schooling, have fallen in these countries in the late 1980s and 1990s, often dramatically. Further, by decomposing changes in non-income dimensions of poverty into shifts in the mean and changes in the distribution of health and education, we show that reduced inequality has contributed to significant reductions in education poverty, and to a lesser extent, health poverty. This, too, is a very different result from the income inequality literature.

In flow models of the labor market, wages are determined by negotiations between workers and employers on the surplus value of a realized match. From this perspective, this paper presents an econometric analysis of the influence of labor market flows on wage formation as an alternative to the traditional specification of wage equations in which unemployment represents Phillips-curve or wage-curve effects. The paper estimates a dynamic wage equation for the Netherlands using a cointegration approach. It finds that labor flows, and notably flows from outside the labor market, are important determinants of both short-run and long-run wage setting.

Foreign outsourcing, labour demand and the choice of functional form (pp. 255-273)

Elasticity of the demand for low-skilled and high-skilled labour in the European Union with respect to foreign outsourcing is estimated, using alternative flexible cost functions. The choice of functional form is apparently not immaterial, as different forms can lead to conflicting conclusions. Tests that can help to discriminate between different forms of functional specification show that a traditional generalized Leontief cost function is often rejected in favour of a minflex Laurent generalized Leontief cost function. Overall, the estimation results show that foreign outsourcing had a significant impact on the demand for low-skilled and high-skilled workers in the sample period. The pattern is however industryspecific and suggests, in line with some recent theoretical models, an ambiguous relationship between outsourcing and labour demand. There is some evidence that high-skilled labour and capital are (relative) complements.

For a sample of six countries with dirty/free float regimes over 1999-2002--the United States, Japan, the Czech Republic, Poland, Switzerland, and the United Kingdom, we investigate whether paired currencies exhibit a pattern of asymptotic dependence on the euro. That is, whether an extremely large appreciation or depreciation in the nominal exchange rate of one country might transmit to the euro, and vice versa. In addition, we investigate whether stock markets of European countries, outside the Euro zone, have exhibited extreme-value dependence on their exchange rates against the euro. In general, after controlling for volatility clustering and inertia in returns, we do not find evidence of extreme-value dependence either between paired exchange rates or between paired stock indices and exchanges rates. However, for asymptotic independent paired returns, we find that tail dependency of exchange rates is stronger under large appreciations than under large depreciations. In addition, we find a weak association between large currency depreciations and declining stock prices.

The public-private sector wage gap in Scotland in 2000 is analysed using the extension sample of the British Household Panel Study (BHPS). Employing a switching regression model, and testing for double sample selection from the participation decision and sector choice, the wage gap is shown to be 10 % for males and 24 % for females. For males this is mainly due to differences in productive characteristics and selectivity, while for females the picture is more ambiguous. Findings also suggest that there exists a male private sector wage premium. While there is no evidence of a sample selection bias for females, the sector choice of males is systematically correlated with unobservables. Furthermore, the structural switching regression indicates that expected wage differentials between sectors are an important driving force for sectoral assignment.

The opportunity cost of being constrained by the type of assets: Bonds only or stocks only (pp. 325-343)

I explore investors' welfare losses when they restrict themselves to invest in either stocks only or bonds only, but not in both. The restriction gives investors sub-optimal asset allocations that result in welfare losses. To measure these welfare losses I compare "only stock indices and Treasury bills" optimal portfolios and "only bond indices and Treasury bills" optimal portfolios with "stock and bond indices and Treasury bills" optimal portfolios using the concept of proportionate opportunity cost along with various CRRA utility functions. The original historical asset returns data set is used with a VAR in generating joint returns distributions for the portfolio formation period. I show that for investors with low levels of risk aversion welfare losses do not exceed 1.5% of initial wealth when they invest sub-optimally. For investors with medium and high levels of relative risk aversion, suboptimal portfolios of only one type of assets, stocks only or bonds only, along with Treasury bills, give expected utility about as high as optimal portfolios that include both types of assets, stocks and bonds.

Amalia Morales-ZumaqueroUniversity of MÃ¡laga and Centro de Estudios Andaluces

Explaining real exchange rate fluctuations (pp. 345-360)

This paper attempts to explain the sources of real exchange rate fluctuations for a set of advanced economies and Central and Eastern European transition economies. To that end, we first estimate structural (identified) vector autoregression (SVAR) models, and decompose real and nominal exchange rate movements into those caused by real and nominal shocks. We then complete the previous step with an impulse-response analysis. There is evidence of instability in the variance decomposition of the real exchange rates for advanced economies across samples, with a growing importance of nominal shocks. Nominal shocks are also important in some transition economies.

This paper presents several methods and discusses salient issues pertaining to the use of reduced-form models to estimate overcharges in antitrust matters (e.g., price-fixing) where "but-for" prices may be less than actual prices during the anticompetitive period. In particular, two common types of reduced-form estimations are discussed: the "dummyvariable approach" and the "forecasting approach". Under either methodology, an error correction model is then specified as one way to address technical problems often found in applied time-series analysis - nonstationary data and the existence of short-term and longterm dynamics.

Blejer and Schumacher (1999) were the first to suggest that Central Bank's Value at Risk (VaR), a widely used composite measure of potential portfolio losses in the corporate sector, could be used as an early warning indicator of financial crises. We extend their research in two aspects. First, we develop an operational model to calculate Central Bank's VaR and illustrate the methodology using data from the recent financial crisis in Argentina. Second, we compare the predictive performance of diverse measures based on the VaR approach to that of another well known early warning system, the signals approach, and several univariate leading indicators. The results reveal a strong relationship between the measures proposed and the crisis. Furthermore, one of the measures provides higher accuracy and announces the probability of a crisis sooner than the competing indicators.

The stochastic approach to index numbers has attracted renewed attention in recent times (e.g., Clements and Izan, 1981 and 1987; Diewert, 1995; Giles and McCann, 1994; and Selvanathan and Rao, 1994). One of the attractions of this approach is that it provides standard errors for the index numbers. This paper reviews the stochastic approach and extends the existing work by presenting an alternative approach to measure the rate of inflation. This approach has been demonstrated using consumption expenditure data for three countries, Australia, the United Kingdom (UK) and the United States (US).

Glen P. JenkinsQueen's University and Eastern Mediterranean UniversityChun-Yan KuoQueen's University and National Chiao Tung University

Evaluation of the benefits of transnational transportation projects (pp. 1-17)

In this paper an analytical framework has been developed to evaluate the primary beneficiaries of cargo traffic generated by transnational transport projects. In the transportation economics literature, the economic impact of infrastructure projects on cargo traffic has not been developed as fully as for passenger traffic. In much of the previous literature it is often assumed that consumers of the traded goods would receive the full benefits from the reduction in logistics and transportation costs. This paper has shown that whether the goods are traded internationally or regionally is a key factor in the allocation of the economic benefits arising from the reduction in the cost of cargo transportation. The analytical framework developed in the paper is applied to the evaluation of the impacts of the proposed Buenos Aires-Colonia binational bridge project.

Permit trading and stability of international climate agreements (pp. 19-48)

We analyze the implication of different allocation schemes of CO2-emission permits for stability and the success of international climate agreements. Our model combines a game theoretical with an empirical module that comprises 12 world regions and captures important dynamic aspects of the climate change problem. We consider seven different permit allocation schemes. Two "pragmatic schemes" allocate permits according to a uniform emission reductio quota, five "equitable schemes" allocate permits based on some normative criteria frequently discussed in the literature permit trading can raise participation and the success of climate agreements, but pragmatic schemes are superior to equitable ones.

This paper is concerned with changes in the distribution of income sources in Uruguay after the late eighties. An apparent stability in the distribution of total incomes is hiding deep transformations affecting the generation of that income. The distribution across all income earners at the end of the eighties exhibited two well-distinguished poles, each associated with one of the main income sources: pension benefits and wages. This bimodality diminished during the nineties due to the reduction in polarization by income sources. In the same period we find that in the case of labor earnings there was a net transfer of population mass from the middle of the distribution to both extremes, which results in an increasing polarization within this income source. This phenomenon resembles the Anglo-Saxon experience of the shrinking middle class.

Stock prices and bank loan dynamics in a developing country: The case of Malaysia (pp. 71-89)

This paper estimates a six-variable VAR model and simulates generalized impulse response functions to assess dynamic interactions between bank loans and stock prices and evaluate whether bank loans play a role in transmitting financial shocks to the real sector. We find evidence that bank loans react positively to the increase in stock prices but there seems to be no influence from bank loans to stock prices. Similarly, bank loans seem to accommodate expansion in real output with, again, no influence of bank loans on real economic activity. Interestingly, despite the noted currency mismatch of bank assets and liabilities as a factor that aggravates the currency crisis, we find no evidence that the exchange rate fluctuations have impact on bank lending. If anything, the exchange rate seems to affect bank lending activities through its effects on real output and stock prices. From the dynamic responses, we tend to conclude that bank loans play no significant role in transmitting stock market shocks to the real sector. An important implication from our analysis is that the health of the banking sector depends crucially on stock market stability and real output stability. Additionally, policy attempts to stimulate bank loans as a way to boost stock market activities as well as to expand real activities may be futile.

Using data for publicly traded companies from the UK and two transition countries, the Czech Republic and Poland, we analyze the relationship between ownership concentratio and performance while also accounting for the effect of hostile takeover threats on this relationship. Some argue that ownership concentration will improve performance by making the owners more willing or able to monitor managers. Others argue that in the presence of efficient markets, market monitoring (via the threat of hostile takeovers) will discipline the managers. Our results show that concentration is insignificant in explaining performance both in the transition countries, where market monitoring is supposedly weak, and in the UK, where market monitoring is supposedly strong.

Kristen MonacoCalifornia State University Long BeachTaggert J. BrooksUniversity of Wisconsin, La CrosseJohn BitzanNorth Dakota State University

A time series analysis of wages in deregulated industries: A study of motor carriage and rail (pp. 105-118)

Using time series techniques, we contrast the impact of deregulation in trucking and rail labor markets. During regulation both labor markets were characterized by wages considerab y higher than manufacturing wages. In fact, trucking and rail wages had a stable, deterministic relationship prior to deregulation. After deregulation, however, the mean trucking wages fell considerably, approaching manufacturing wages, while rail wages remained relatively constant. We also find that deregulation's negative impact on trucking wages was nondiscrete and occurred primarily between 1980 and 1984.

This paper investigates productivity growth and technical efficiency in the Greek banking industry for the period 1982-1997. It also compares the 1982-92 and 1993-97 sub-periods, since after 1992 the Greek banking sector experienced substantial changes. The Malmquist productivity index and the DEA method are used to measure and decompose productivity growth and technical efficiency, respectively. Productivity growth is higher after 1992. Recent growth is mainly attributed to technical progress, while until 1992 growth is mainly attributed to improvements in efficiency. Furthermore, after 1992, pure efficiency is higher, and scale efficiency is lower, indicating that although banks achieved higher pure technical efficiency, they moved away from optimal scale. Finally, Tobit results show that size and specialization have positive effects on both pure and scale efficiency.

Johannes SauerRoyal Veterinary and Agricultural University, Copenhagen (KVL)Klaus FrohbergCenter for Development Research, University of BonnHenrich HockmannInstitute for Agricultural Development in Central and Eastern Europe, Halle

The availability of efficiency estimation software - freely distributed via the internet and relatively easy to use - recently inflated the number of corresponding applications. The resulting efficiency estimates are used without a critical assessment with respect to the literature on theoretical consistency, flexibility and the choice of the appropriate functional form. The robustness of policy suggestions based on inferences from efficiency measures nevertheless crucially depends on theoretically well-founded estimates. This paper adresses stochastic efficiency measurement by critically reviewing the theoretical consistency of recently published technical efficiency estimates. The results confirm the need for a posteriori checking the regularity of the estimated frontier by the researcher and, if necessary, the a priori imposition of the theoretical requirements.

Credit rationing and the financial structure of Italian small and medium enterprises (pp. 167-184)

Our aim is to analyze the effect of public subsidies on the development path of Italian small and medium enterprises (SMEs). Public subsidies to SMEs have been often used with the aim of favoring economic growth in less developed regions. The main theoretical arguments justifying this intervention are related to the idea that public subsidies can solve lack-ofcapital problems deriving from asymmetric information. According to Stiglitz and Weiss (1981), public subsidies to rationed firms can reduce the informational gap, leading subsidized firms to reduce their financial constraints and to increase their investment levels. Results obtained modelling leverage, performance and investment behaviour in a panel of around 1,900 enterprises over the years 1989 to 1994 seem to confirm the working hypotheses. However, they can not be considered as conclusive and further research is needed in this context.

Pornography and social ills: Evidence from the early 1990s (pp. 185-214)

Beginning from the hypothesis that private post office boxes accommodate consumption of pornographic magazines by lowering some aspects of the cost (risk of social stigmatization) associated with the purchasing of such items, I demonstrate that a positive correlation between the abundance of such boxes and the subscription rate to Penthouse magazine across markets in the United States can be observed. I then proceed to estimate the effect of pornography on violent sex crimes and family instability, with and without using P.O. Box availability as an instrumental variable. Results suggest that unobservable population characteristics severely bias upward the estimated harmfulness of adult magazines. My OLS estimates imply, like several previous studies, that consumption of pornography contributes to both higher frequencies of rapes and divorces. When instrumental variables are employed, however, the correlation between rapes and pornography turns negative while the statistical significance of the coefficient for pornography on the rate of divorces disappears.

Government exchange rate regime choice is constrained by both political and economic factors. One political factor is the role of special interests: the larger the tradable sectors exposed to international competition, the less likely is the maintenance of a fixed exchange rate regime. Another political factor is electoral: as an election approaches, the probability of the maintenance of a fixed exchange rate increases. We test these arguments with hazard models to analyze the duration dependence of Latin American exchange rate arrangements from 1960 to 1999. We find substantial empirical evidence for these propositions. Results are robust to the inclusion of a variety of other economic and political variables, to different time and country samples, and to different definitions of regime arrangement. Controlling for economic factors, a one percentage point increase in the size of the manufacturing sector is associated with a reduction of six months in the longevity of a countryÂ’s currency peg. An im pending election increases the conditional likelihood of staying on a peg by about 8 percent, while the aftershock of an election conversely increases the conditional probability of going off a peg by 4 percent.

We address the efficiency in education and health sectors for a sample of OECD countries by applying two alternative non-parametric methodologies: FDH and DEA. Those are two areas where public expenditure is of great importance so that findings have strong implications in what concerns public sector efficiency. When estimating the efficiency frontier we focus on measures of quantity inputs. We believe this approach to be advantageous since a country may well be efficient from a technical point of view but appear as inefficient if the inputs it uses are expensive. Efficient outcomes across sectors and analytical methods seem to cluster around a small number of core countries, even if for different reasons: Japan, Korea and Sweden.

This paper extends the existing estimation methods to allow estimation under simultaneous price and output uncertainty. In contrast with the previous literature, our approach is applicable to the direct and indirect utility functions and does not require specification and estimation of the production function. We derive estimating equations for the two most common forms of output risk (additive and multiplicative risks) and empirically determine which form is appropriate. Moreover, our estimation method can be utilized by future empirical studies in several ways. First, our method can be extended to include multiple sources of uncertainty. Second, it is applicable to other specifications of output uncertainty. Third, it can be used to conduct hypothesis tests regarding the functional forms and distributions. Furthermore, it enables the future empirical researcher to empirically verify/ refute the theoretical comparative statics results.

Computable general equilibrium (CGE) modeling has provided a number of important insights about the interplay between environmental tax policy and the pre-existing tax system. In this paper, we emphasize that a labor market policy of recycling tax revenues from an environmental tax to lower employersÂ’ non-wage labor cost depends on how the costs of labor are modeled. We propose an approach, which combines neoclassical substitutability and fixed factor proportions. Our concept implies a user cost of labor which consists of the market price of labor plus the costs of inputs associated with the employment of a worker. We present simulation results based on a CO2 tax and the recycling of its revenues to reduce the non-wage labor cost. One simulation is based on the market price of labor and the other on the user cost of labor. We found a double dividend under the first approach but not under the second one.

In a multi community environment local authorities compete for tax base. When monitoring is imperfect, agents may decide not to pay in their community (evasion), and save the tax difference. The agent decision on where to pay taxes is based on the probability of getting caught, the fine he eventually will have to pay and the time cost of paying in a neighbor community. First, we prove that if the focus of the agentsÂ’ decision is the probability of getting caught and the fine, only the richest people evade. If instead, the key ingredient is the time cost of evading, only the poorest cheat. Second, we test the evasion pattern on the Automobile Registration System in Uruguay using two stochastic dominance tests. The evidence favors in this case the hypothesis that richer people are the evaders.

New evidence on long-run output convergence among Latin American countries (pp. 299-319)

This study assesses long-run real per capita output convergence among selected Latin American countries. The empirical investigation, however, is based on an alternative approach. Strong convergence is determined on the basis of the first largest principal component, based on income differences with respect to a chosen base country, being stationary. The qualitative outcome of the test is invariant to the choice of base country and, compared to alternative multivariate tests for long-run convergence, this methodology places less demands on limited data sets. Using annual data for the period 1960-2000, strong convergence is confirmed for the Central American Common Market. However, an amended version of the test confirms weaker long-run convergence in the case of the Latin American Integration Association countries.

Technology, trade, and income distribution in West Germany: A factor-share analysis, 1976-1994 (pp. 321-345)

This paper examines the determinants of functional income distribution in West Germany. The approach is to estimate a complete system of factor share equations for low-skilled labor, high-skilled labor, capital, energy, and materials, taking account of biased technological progress and increasing trade-orientation. Technological progress is found to reduce the share of low-skilled labor and to raise the share of high-skilled labor. The effect of technology bias on the two labor shares is enhanced by substitution of intermediate inputs for lowskilled labor, which is almost absent in the case of high-skilled labor. Trade-induced changes in the composition of aggregate output tend to mitigate these effects, due to the relatively favorable export performance of low-skill intensive industries. The year-to-year variation in the low-skilled share can be attributed to input prices, biased technological progress, and trade-induced structural change in the proportion 19:77:4. For high-skilled labor and capital, the output composition effect of trade contributes about one percent. The results are robust across several specifications examined.

Price discrimination and market power in export markets: The case of the ceramic tile industry. (pp. 347-370)

This paper combines the pricing-to-market equation and the residual demand elasticity equation to measure the extent of competition in the export markets of ceramic tiles, which has been dominated by Italian and Spanish producers since the late eighties. The findings show that the tile exporters enjoyed substantial market power over the period 1988-1998, and limited evidence that the export market has become more competitive over time.

Siv TaingQueensland University of TechnologyAndrew WorthingtonUniversity of Wollongong

Return relationships among European equity sectors: A comparative analysis across selected sectors in small and large economies. (pp. 371-388)

This paper examines return interrelationships between numbers of equity sectors across several European markets. The markets comprise six Member States of the European Union (EU): namely, Belgium, Finland, France, Germany, Ireland and Italy. The five sectors include the consumer discretionary, consumer staples, financial, industrials and materials sectors. Generalised Autoregressive Conditional Heteroskedasticity in Mean (GARCHM) models are used to consider the impact of returns in other European markets on the returns in each market across each sector. The results indicate that there are relatively few significant interrelationships between sectors in different markets, with most of these accounted for by the larger markets in France, Germany and Italy. The evidence also suggests the consumer discretionary, financial and materials sectors are relatively more interrelated than the consumer staples and industrials sectors. This has clear implications for portfolio diversification and asset pricing in the EU.

Short and long run determinants of private investment in Argentina. (pp. 389-406)

This study provides an empirical analysis of the macroeconomic factors that can potentially affect investment decisions in Argentina in a short, medium and long run perspective. Both the theory and the empirical literature are reviewed in order to identify a private investment function for the last three decades (1970-2000). The results suggest that investment decisions seem to be determined, in the short run, by shocks in returns (exchange rate, trade liberalization) and in aggregate demand. Besides, there is evidence of a Â“crowding-outÂ” effect of public investment. In the long run, the capital accumulation path seems to be closely dependent on both well-developed financial and credit markets and on perspectives of fiscal sustainability.

This paper uses opinion surveys to document discontent with the pro-market reforms implemented by most Latin American countries during the 1990s. The paper also explores four possible sets of explanations for this discontent: (i) a general drift of the populaceÂ’s political views to the left; (ii) an increase in political activism by those who oppose reforms; (iii) a decline in the peopleÂ’s trust of political actors; and (iv) the economic crisis. The paperÂ’s principal finding is that the macroeconomic situation plays an important role in explaining the dissatisfaction with the reform process.

In this paper we reassess the standard Solow growth model, using a dynamic panel data approach. A new methodology is chosen to deal with this problem. First, unit root tests for individual country time series were run. Second, panel data unit root and cointegration tests were performed. Finally, the panel cointegration dynamics is estimated by (DOLS) method. The resulting evidence supports roughly one-third capital share in income, a.

Consequences of firms'relational financing in the aftermath of the 1995 Mexican banking crisis (pp. 53-79)

This paper shows that, in the aftermath of the 1995 banking crisis, relational financing was a two-edged sword for firms listed on the Mexican Securities Market. On the negative side, only bank-linked firms observed on average a dependence on cash stock to finance their investment projects. On the positive side, the banking connection was important to boost their profit rates during the 1997-2000 period, at least for financially healthy firms. These econometric results are derived from dynamic panel data models of investment and profit rates, which are estimated by the Generalized Method of Moments, where level and difference equations are combined into a system.

Dimitris HatzinikolaouUniversity of IoanninaMetodey PolasekFlinders University

The commodity-currency view of the Australian dollar: A multivariate cointegration approach (pp. 81-99)

Using Australian quarterly data from the post-float period 1984:1-2003:1 and a partial system, we identify and estimate two cointegrating relations, one for the interest-rate differential and the other for the nominal exchange rate. Our estimate of the long-run elasticity of the exchange rate with respect to commodity prices is 0.939, which strongly supports the widely held view that the floating Australian dollar is a Â‘commodity currencyÂ’. We also find that the PPP and UIP cannot be rejected so long as commodity prices are included in the cointegrating relations. Our model outperforms the random walk model in forecasting the exchange rate in the medium run.

Pure contagion effects in international banking: The case of BCCIÂ’s failure (pp. 101-123)

We test for pure contagion effects in international banking arising from the failure of the Bank of Credit and Commerce International (BCCI), one of the largest bank failures in the world. We focused on large individual banks in three developed countries where BCCI had established operations, namely the UK, the US, and Canada. Using event study methodology, we tested for contagion effects using time windows surrounding several known BCCI-related announcements. Our analysis provides strong evidence of pure contagion effects in the UK, which have arisen prior to the official closure date. In contrast, there is no evidence of pure contagion effects in the US and Canada.

This paper seeks to examine if the relative size of government (measured as the share of total expenditure in GNP can be determined to Granger cause the rate of economic growth, or if the rate of economic growth can be determined to Granger cause the relative size of government. For this purpose, we first use a bivariate error correction model within a Granger causality framework, as well as adding unemployment and inflation (separately) as explanatory variables, creating a simple Â‘trivariateÂ’ analysis for each of these two variables. The combined analysis of bivariate and trivariate tests offers a rich menu of possible causal patterns. Using data on Greece, UK and Ireland, the analysis shows: i) government size Granger causes economic growth in all countries of the sample in the short run and in the long run for Ireland and the UK; ii) economic growth Granger causes increases in the relative size of government in Greece, and, when inflation is included, in the UK.

The Taiwanese flour industryÂ’s capacity utilization rate has maintained an extremely low level of 40% for more than 20 years. This article sets up a two-stage game model and uses the strategic effect of the firmÂ’s capital investment on its rivalsÂ’ outputs to explain the nature of this excess capacity. The model is tested with panel data from the Taiwanese flour industry by using non-linear three-stage least squares. The evidences indicate that a large capacity built in the past could have been used strategically to reduce other firmsÂ’ outputs, in the context of a concerted action among the incumbent firms.

James OdeckThe Norwegian University of Science and Technology and The Norwegian Public Roads Administration

Evaluating target achievements in the public sector: An application or a rare non-parametric DEA and Malmquist indices (pp. 171-190)

This paper provides an assessment of the extent to which targets set by a public authority are achieved by its operational units. A rare DEA framework and its subsequent Malmquist indices are applied on data comprising 19 units over a four year period of 1996 to 1999. The mean efficiency scores by which targets are achieved across the sample years are moderate, in the range 0.81 to 0.93. Average productivity progress across the sample years has been 26 percent. The results illustrate the usefulness of DEA even when there are no inputs and the decomposable Malmquist index for productivity is an asset in exploring causes of productivity growth.

This study estimates marginal rates of return to investment in schooling in 12 countries. Significant systematic nonlinearity in the marginal rate of return is found. In particular, the marginal rate of return is increasing significantly at low levels of education, and decreasing significantly at high levels of education. This may help explain why estimates of the return to schooling are often considerably higher when instrumenting for education.

In this paper we investigate Dutch corporate liquidity management in general, and target adjustment behaviour in particular. To this purpose, we use a simple error correction model of corporate liquidity holdings applied to firm-level data for the period 1977-1997. We confirm the existence of long-run liquidity targets at the firm level. We also find that changes in liquidity holdings are driven by short-run shocks as well as the urge to converge towards targeted liquidity levels. The rate of target convergence is higher when we include more firm-specific information in the target. This result supports the idea that increased precision in defining liquidity targets associates with a faster observed rate of target convergence. It also suggests that the slow speeds of adjustment obtained in many macro studies on money demand are artefacts of aggregation bias.

Karl AigingerAustrian Institute of Economic Research, and University of LinzStephen W. DaviesUniversity of East Anglia

Industrial specialisation and geographic concentration: Two sides of the same coin? Not for the European Union (pp. 231-248)

Some recent studies have shown that specialisation of countries has tended to increase, while regional concentration of countries has tended to decrease. This seems to be counterintuitive at first glance. In this paper, we use the entropy index - as the indicator of structural change with the neatest aggregation properties to show how this divergence can happen. The main purpose of the paper is methodological, but we also apply the methodology to a specific case study: Manufacturing in the European Union since 1985. We confirm for this interesting period that increasing industrial specialisation has been offset by faster growth in the smaller Member States, with the net effect that industries have become somewhat less geographically concentrated. In terms of economic geography the evidence is in line with the second part of the inverted U-curve (where decreasing transport costs eventually foster de-concentration). This is no contradiction to increasing specialisation of countries in specific industries as predicted by many models in the old as well as the new trade theory.

Sustainability of the US current account deficit: An econometric analysis of the impact of capital inflow on domestic economy (pp. 249-269)

The purpose of this paper is to estimate, by using the recent econometric techniques of unit root testing and Johansen-Juselius cointegration technique (1990), the impact of foreign capital inflow on the volume and efficiency of domestic investment in the United States during the period, 1973-1999. A battery of diagnostic tests is employed to check the validity and robustness of the estimated results. Evidence suggests that capital inflows have had a significant positive effect on the volume of US investment, but the effect on the efficiency of investment has been minimal. These findings imply that, while achieving current account balance is important, it is equally important to sustain and augment the beneficial impact of capital inflow by creating a more conducive investment climate. Given our limited ability to influence current account balance, this seems to be a more pragmatic policy option for dealing with the US current account imbalance.

This paper examines the degree and recent evolution (1988-2001) of export-price dispersion among European Union countries. It also explores the effect of exchange rates on exportprice dispersion by reviewing the experience of some European countries that participated in the exchange rate stability zone. The results indicate that export-price dispersion across European Union countries was usually lower than across OECD countries. Moreover, although there is little evidence of convergence, this is stronger across European Union countries. Finally, even though price dispersion was often lower across European Union countries where exchange rates have been relatively stable than across countries with relatively volatile exchange rates, exchange-rate stability has not significantly contributed to export-price convergence across participating countries over the sample period.

Business cycles in Mexico and the United States: Do they share common movements? (pp. 303-323)

In this document I apply a recently developed econometric technique to prove the existence of common movements between time series. Said methodology is used to test and measure the existence of common cycles between the economies of Mexico and the United States for the 1993-2001 period. It is found that both economies share a common trend and a common cycle. Also, given the existence of one common cycle between these economies, it is found that transitory shocks affecting MexicoÂ’s GDP are more important than when a conventional trend-cycle decomposition methodology is applied. Finally, it is shown that there are efficiency gains in forecasting by considering the common cycle restriction in a bivariate vector error correction model that includes the Mexican and the U.S. GDPs.

We apply semiparametric efficient estimation procedures for a seemingly unrelated regression model where the multivariate error density is elliptically symmetric to study the efficiency of the foreign exchange market. We consider both cointegrating regressions and standard stationary regressions. The elliptical symmetry assumption allows us to avoid the curse of dimensionality problem that typically arises in multivariate semiparametric estimation procedures, because the multivariate elliptically symmetric density function can be written as a function of a scalar transformation of the observed multivariate data. We test the unbiasedness hypothesis on both weekly and daily exchange rate data and strongly reject unbiasedness at the weekly horizon, but fail to reject the unbiasedness hypothesis on the daily data. Estimates of the semiparametric procedure in some cases differ substantially from traditional OLS estimates.

The end of the 1990Â’s saw a number of foreign automobile manufacturers become the largest shareholders in several Japanese automobile manufacturers. It seems logical to conclude that a firm only enters into a partial ownership arrangement (POA) if it is profit maximizing. However, research to date has treated POAs as if exogenous to the model. This paper develops a model that assumes POAs are determined endogenously. Data for the Japanese automobile industry are then used to investigate the factors that determine whether a firm enters into a POA, and the effects a POA has on the price-cost margin. The findings of this paper suggest that while both foreign and domestic firms take an interest in product mix when exploring POAs in the Japanese market, they have differing profit incentives. Furthermore, the level of ownership has a positive effect on POAs.

Leviathan and pure public goods in a federation with mobile populations (pp. 369-389)

This paper investigates properties of the second best allocation in a federation where regional governments provide a pure public good non-cooperatively and policy makers are neither entirely benevolent nor wholly self-serving. A high degree of household mobility across regions forces the governments to raise the efficiency of the public good, however, it also helps to waste resources. It is shown that regional Leviathans not only under-provide the public good but also decrease the amount of wasteful expenditures as households become less mobile. Central governmentÂ’s intervention can enhance efficiency if households are attached to particular regions.

The real exchange rate process and its real effects: The cases of Mexico and the USA (pp. 1-25)

Exchange rate management is a salient macroeconomic issue, especially in developing countries. In this paper, we study political economy factors that may affect the real exchange rate (RER) process and the real economic effects of the RER. We review recent literature on the effects of elections on the exchange rate, and adapt BallÂ’s (1992) model to show that uncertainty about the future course of policy may make more appreciated RERÂ’s less predictable. We also review the literature on the real effect of RER appreciations and of RER uncertainty. We then construct a simultaneous GARCH-M model of the joint determination of the RER and output capable of testing our hypotheses simultaneously in a single model. We estimate the model using data first from Mexico, a developing country, and the US. In Mexico we find that elections significantly affect the evolution of the RER, that more appreciated RERs are less predictable, that RER depreciations lower output growth and that RER uncertainty lowers output growth, even when controlling for its wellstudied effect on trade. By contrast, none of these effects are found in the US data.

What do unions do at the large scale? Macro-economic evidence from a panel of OECD countries (pp. 27-46)

This paper investigates the long-run relationship between trade unionism and productivity using a panel data set comprising of 18 OECD economies. Much of the existing evidence on this issue derives from micro-economic studies, with limited attention paid to long-run dynamics and economy-wide effects. Using the mean group and pooled mean group estimation techniques on cross-country panel data, the paper offers support to the "productivity-increasing face of unionism" hypothesis, revealing a positive relationship between trade union density and per worker output.

This paper discusses the long run effect of changes in the age distribution of Spanish population on the unemployment rate, disaggregated by sex and age segments in the light of cointegration theory given the non stationarity of the series. Four main results are obtained. First, empirical analysis does not provide a clear scheme concerning the long run relationships between population variables and the specificunemployment rates for different groups. Second, as a first approximation one can detect the existence of, at least, one long run equilibrium relationship in all sex-age groups, except for the ones including the middle aged unemployed female workers and oldest unemployed female workers. Third, a more thorough analysis enables us to justify the existence of such long run relationships for the youngest male workers and middle aged male workers. One cannot argue, however, a joint evolution of population variables and the unemployment rates associated with female workers and to the oldest male workers. Fourth, the short run dynamics of unemployment rates for the youngest (male and female workers) and the middle age male workers is affected by the transitory deviations from these long run relationships. Hence, from an applied economics point of view, the result stresses the likely failure of employment policies which do not take into account the heterogeneous composition of unemployed workers. It stresses the need to design particular policies for specific groups of workers depending on their age and sex characteristics.

More analysts, better ratings: Do rating agencies invest enough in less developed countries? (pp. 77-98)

Rating agencies' track record is good in developed countries but poor in emerging economies. Why? Given the almost-monopolistic structure of the industry, we conjecture that agencies might underinvest in information gathering. We propose an indicator quantifying the agencies' effort to gather information and assess whether greater effort affects rating levels. We detect: (i) absolute underinvestment for non-OECD sovereigns (less effort in spite of greater opaqueness); (ii) relative underinvestment for non-OECD firms compared with OECD ones (though the former receive a larger effort, more intense effort boosts firm ratings in non-OECD countries while depressing them in OECD countries).

The purpose of this paper is to test the main hypotheses of the recent theoretical literature on the political economy of reform for the case of the Latin American countries between 1985 and 1995. The paper first reviews the literature and extracts the main testable hypotheses. Then, a system of indices that measure the extent of reform in five policy areas is presented. These indices are used as the dependent variables in panel regressions where the main explanatory variables are indicators of crisis, political variables and indicators of channels of contagion. We find very strong support for the well-known hypothesis that crises make reform viable and also for the (less theoretically sound) hypotheses that reforms are more likely at the beginning of government periods. None of the hypotheses on the role of political and distributional variables, the importance of compensation schemes or contagion, finds support in our results. Rather disappointingly, however, most of the reforms seem to have responded to a process of convergence.

John A. TaurasUniversity of Illinois at Chicago and National Bureau of Economic Research

Public policy and some-day smoking among adults (pp. 137-162)

While much is known about the impact of public policy on current cigarette smoking among adults, very little is known about the determinants of some-day smoking. This paper investigates the impact of cigarette prices, clean indoor air laws, and other socioeconomic factors on adult cigarette demand. Special emphasis is placed on examining the determinants of some-day smoking among adults. The estimates from this study clearly indicate that increasing the price of cigarettes, will decrease the number of people who currently smoke, will decrease the number of every-day smokers, and will decrease the number of cigarettes smoked on average among some-day smokers. Finally, clean indoor air laws are found to have a limited impact on current and some-day smoking.

State executions, deterrence, and the incidence of murder (pp. 163-193)

This study employs a panel of U.S. state-level data over the years 1978-1997 to estimate the deterrent effect of capital punishment. Particular attention is paid to problems of endogeneity bias arising from the non-random assignment of death penalty laws across states and a simultaneous relationship between murders and the deterrence probabilities. The primary innovation of the analysis lies in the estimation of a simultaneous equations system whose identification is based upon the employment of instrumental variables motivated by the theory of public choice. The estimation results suggest that structural estimates of the deterrent effect of capital punishment are likely to be downward biased due to the influence of simultaneity. Correcting for simultaneity, the estimates imply that a state execution deters approximately fourteen murders per year on average. Finally, the results also suggest that the announcement effect of capital punishment, as opposed to the existence of a death penalty provision, is the mechanism actually driving the deterrent effect associated with state executions.

The Traditional Brokers: What are their Chances in the Forex? (pp. 205-220)

The electronic brokers compete with the traditional brokers. The electronic brokers offer lower costs, increased speed and a better guarantee of transparency and of anonymity. The only real advantage of the traditional brokers is the gathering of information. We investigate whether the traders in the foreign exchange market consider that to be crucial, which is equivalent to asking Â“Do traditional brokers have any chance in the forex?Â” We build a simple model and use the results of a questionnaire that we elaborated and that was sent to the users of the brokersÂ’ services in the Portuguese foreign exchange market. We also use transaction data from the most important dealer in the Portuguese market. Considering this dealer to be representative, we conclude that the main advantage of the traditional broker is not much valued by the dealers. This does not leave a promising future for the traditional broker.

Testing the Order of Integration with Low Power Tests. An Application to Argentine Macro-variables (pp. 221-246)

The low power of available econometric tests is an important problem in applied research on unit roots and related issues. Based on the principle of methodological triangulation, the problem should be analyzed from different points of view in order to increase the validity of the results. Following this approach a strategy to test the order of integration in time series is presented using a sequence of eleven consolidated tests. In this way it is possible to determine the persistence of shocks, to specify the best strategy for trend-cycle decomposition and to obtain additional information useful for public policies. As an application of the methodology, the integration properties in the main 14 Argentine macroeconomic variables are studied. A classification of them in four homogenous groups according to their order of integration is obtained.

A Note on Business Cycle Non-Linearity in U. S. Consumption (pp. 247-253)

The recently examined durability-asymmetry hypothesis of Cook (1999) is re-evaluated using the diagnostic tests of time deformation proposed by Stock (1987, 1988). An application of these tests to disaggregated data on U.S. consumersÂ’ expenditure provides further support for this hypothesis, with the findings given an economic interpretation in terms of variables evolving at differing speeds over different phases of the business cycle. Additionally, building upon the studies of Cover (1992), Karras (1996) and Rhee and Rich (1995), recent research by Arden et al. (2000) has shown the relaxation of the assumptions of linearity and symmetry typically employed in macroeconometric models to result in monetary policy having clear asymmetric effects on the economy. In particular it was shown that expansionary monetary policy as given by a reduction in the interest rate, has greater effects than contractionary policy (an increase in the interest rate), and that this becomes more apparent when the economy is in recovery rather than recession. The finding of nonlinearity in U.S. consumption therefore has major implications for econometric modelling and policy analysis.

The accuracy of technical efficiency measures is important given the interest in such measures in policy discussions. In recent years the use of stochastic frontiers has become popular for estimating technical inefficiency, but estimated inefficiencies are sensitive to specification errors. One source of such errors is heteroscedasticity. This paper addresses this issue by extending the Hadri (1999) correction for heteroscedasticity to stochastic production frontiers and to panel data. It is argued that heteroscedasticity within an estimation can have a significant effect on results, and that correcting for heteroscedasticity yields more accurate measures of technical inefficiency. Using panel data on cereal farms, it is found that the usual technical efficiency measures used in stochastic production frontiers are significantly sensitive to the extended correction for heteroscedasticity.

Commercial bank credit is a useful tool for promoting economic growth especially at the early stages of development. It has been observed that between 1996 and the early part of 2000, the growth rate of real credit to the private sector declined significantly in Namibia. This period coincided with observed strong demand for commercial bank loans. There has therefore been public discourse on the possibility of a restriction in the supply of credit by commercial banks and hence the occurrence of a credit crunch in the economy since commercial bank lending capacity did not fall. This paper attempts to provide some evidence in this regard by examining the main determinants of commercial bank credit in the economy and ascertaining if credit has been demand or supply constrained. This has been done through a survey of disaggregated data in the banking industry and an estimation of a switching regression model to identify regimes of excess supply and demand. Although it is difficult to determine in the face of obvious demand factors the extent to which the credit slowdown can be attributed to credit supply factors, our results show that supply factors did play a major role.

This paper applies the gravity trade model to assess Mercosur-European Union trade, and trade potential following the agreements reached recently between both trade blocs. The model is tested for a sample of 20 countries, the four formal members of Mercosur plus Chile and the fifteen members of the European Union. A panel data analysis is used to disentangle the time invariant country-specific effects and to capture the relationships between the relevant variables over time. We find that the fixed effect model is to be preferred to the random effects gravity model. Furthermore, a number of variables, namely, infrastructure, income differences and exchange rates added to the standard gravity equation, are found to be important determinants of bilateral trade flows.

The 1990s in Latin America: Another Decade of Persistent Inequality, but with Somewhat Lower Poverty (pp. 317-339)

This paper processes 76 household surveys from 17 Latin American countries to document changes in poverty and inequality during the 1990s, and performs an analysis of the effect of economic reforms on inequality and poverty by using an expanded data base of 94 surveys spanning the 1977-2000 period. We show that there is no country in Latin America where inequality declined during the 1990s. Poverty declined in 10 or 11 out of the 17 countries for which household surveys are available to us, depending on the poverty measured used. Persistently high inequality inhibited further poverty reduction. One important factor contributing to the persistently high inequality level is financial liberalization. Trade liberalization and slight inequality-reducing effect.

This paper analyzes the ad hoc decision of three Asian countries to peg their currency to the U.S. dollar prior to the Asian crisis. It uses the Sjaastad model to estimate the optimal basket weights for Thailand, Korea, and Singapore. The analysis in this paper differs from the optimal basket research since we are not searching for an ad hoc optimal basket; rather, the basket is the solution to the problem. For Thailand and Korea, the correct weights of the dollar in the basket are estimated to be 44 and 65 percent, respectively, which differ significantly from the actual weight of 100 percent for the U.S. dollar in their currency basket prior to the 1997 Asian crisis. Singapore, with a weight of 85 percent for the U.S. currency, is closer to a dollar peg, and therefore was less affected by the large depreciation of the European currencies and the yen toward the dollar that occurred prior to the Asian exchange rate crisis. Besides the fact that Singapore had better economic fundamentals prior to the crisis, the fact that the optimal basket for that country is closer to a dollar peg is an additional reason why its economy was less severely hit by the crisis.

Currency Substitution and the Demand for Money in Five European Union Countries (pp. 361-383)

The high degree of economic integration has led to an increased degree of currency substitution in the EU countries, which could bring instability in national money demand functions while an EU-wide money demand function could be more stable. Currency substitution usually takes the form of cross border deposits (CBD), which are not included in the traditional monetary aggregates. Thus, extended monetary aggregates that include the relevant CBDs are defined in this study. In order to investigate the implications of currency substitution for the stability of the demand functions, the traditional and extended monetary aggregates for five EU countries are defined in addition to EU-wide monetary aggregates. The estimated EU-wide demand for extended money appears to be stable suggesting that there is scope for monetary policy at the European level. However, the stability of the area-wide aggregate has been impaired when the relevant CBDs are not included.

We estimate in this paper the market risk implied by the prices of different options traded in the Brazilian stock market. The fundamental theory to handle this problem is the one implied by the Arrow-Debreu contingent claim concept. Using that theory, we are able to construct the term structure of market risk, and to obtain a surface that provides slices for a particular Â“volatility smile.Â” The methodology that we use follows the one proposed by Shimko (1993), which is able to calculate a non-lognormal probability density function (PDF) consistent with the volatility observed in a relatively small sample of option prices. This methodology goes beyond the one proposed originally by Black and Scholes (1973), since it does not require log-normality of the PDF nor that volatility remains constant.

Vector Autoregressions, Policy Analysis, and Directed Acyclic Graphs: An Application to the U.S. Economy (pp. 1-24)

The paper considers the use of directed acyclic graphs (DAGs), and their construction from observational data with PC-algorithm TETRAD II, in providing over-identifying restrictions on the innovations from a vector autoregression. Results from SimsÂ’ 1986 model of the US economy are replicated and compared using these data-driven techniques. The directed graph results show SimsÂ’ six-variable VAR is not rich enough to provide an unambiguous ordering at usual levels of statistical significance. A significance level in the neighborhood of 30 % is required to find a clear structural ordering. Although the DAG results are in agreement with SimsÂ’ theory-based model for unemployment, differences are noted for the other five variables: income, money supply, price level, interest rates, and investment. Overall the DAG results are broadly consistent with a monetarist view with adaptive expectations and no hyperinflation.

International Trade, Productivity Growth, Education and the Wage Differential: A Case Study of Taiwan (pp. 25-48)

The cause of changes in the wage differential between skilled and unskilled labor has been an important subject of debate for several decades. International trade and productivity growth are two main causes that have been suggested from large country studies. Recent research proposes that education is another influence. All three causes have been significantly associated with TaiwanÂ’s economic development. This paper attempts to contribute to the literature by investigating the wage differential in Taiwan, a small open economy. A Dynamic Intertemporal General Equilibrium (DIGE) model is used to perform theoretical simulation. An Error Correction Model (ECM) incorporating both short- and long-run effects is employed to accomplish the empirical examination. That education and international trade are important causes of changes in the wage differential is substantiated by Taiwanese data. Productivity growth has a significant influence on the wage differential in the short run but not in the long run.

Each company faces day to day investment opportunities. Just by staying in business the company is taking a decision of reinvesting capital. These opportunities have to be fairly valued to overcome misallocation of resources. A project with high growth opportunities requires high reinvestments to take full advantage of them until it reaches its mature stage. These investments can be seen as a succession of call options on future growth. When a company with such prospects is valued using the discounted cash flow technique and growth is taken implicitly in the growing cash flows and the residual value, the value thus obtained will be higher than the true one (under certain circumstances). Technology advances and the effects of globalization create enormous growth opportunities, and so misvaluation risks are higher.

Measuring Competition in the U.S. Airline Industry Using the Rosse-Panzar Test and Cross-Sectional Regression Analyses (pp. 73-93)

We employ the Rosse-Panzar test to assess market performance in selected airport-pairs originating from Atlanta. The Rosse-Panzar test stands in the tradition of the New Empirical Industrial Organization. It is based on the comparative statics of a reduced form revenue equation. Therefore, it is less powerful than structural models, but it offers the advantage of less stringent data requirements and reduces the risk of model misspecifications. The test statistic allows us in most airport-pairs to reject both conducts consistent with the Bertrand outcome, which is equivalent to perfect competition, and the collusive outcome, which is equivalent to joint profit-maximization. Rather, the test statistic suggests that behavior is consistent with a range of intermediate outcomes between the two extremes, including, but not limited to the Cournot oligopoly. In the second part of the paper, a cross-section pricing regression complements the Rosse-Panzar test. It shows that the presence of low-cost competition in an airport-pair reduces the average fare significantly.

The paper analyses the efficiency and the distributional effects of eliminating a tariff in a protected sector, in a Heckscher-Ohlin model of trade with costs of adjustment. The tariff can be eliminated at the onset or after a while. In case of postponing it the government may pre-announce the policy change or may not do it and surprise the private sector. It is shown that while large adjustment costs reduce the efficiency gains from trade liberalisation, small to moderate adjustment costs may raise the efficiency gains from a pre-announced liberalisation. The adjustment costs reduce the effects on factor returns from a sudden unanticipated liberalisation. The distributional effects of trade liberalisations are more complex when the policy is pre-announced. For small and moderate levels, the adjustment costs may increase the effects of the policy on factor returns. Also, the Â“value of the announcementÂ” rises with the adjustment costs.

Unemployment in France rose steadily from the early-seventies to the mid-eighties. Since the mid-eighties it has continued to experience fluctuations around a very high average level. Equilibrium unemployment theories are a useful framework within which to account for these developments. A multivariate estimation of the WS-PS model on macroeconomic quarterly data, which includes a larger number of potential unemployment determinants than earlier work, allows an enriched reading of the rise in French unemployment and of its persistence at a high level. We estimated it using a conditional VAR-ECM model, which is based upon the weak exogeneity properties of variables over the 1970-1/1996-4 period. The rise in equilibrium unemployment by 10 points in 25 years can essentially be explained by the rise in tax and social wedge, the slowdown in labour productivity and the deterioration of job security. Terms of exchange and skill mismatch account for only a slim part of the rise in equilibrium unemployment.

How Can We Use the Result from a DEA Analysis? Identification of Firm-relevant Reference Units. (pp. 157-175)

Two types of guidelines can be obtained from a DEA (data envelopment analysis) analysis. Firstly, the firm can reduce input or increase production according to the DEA results. Secondly, an inefficient firm might be able to identify reference units. This makes it possible for the inefficient firm to, on site, study production that is more efficient, and thereby get information on e.g. efficient organisational solutions. In this study, we focus on how to detect these firm-relevant reference units. While applying the existing methods for identification of reference units, i.e. the intensity variable method and the dominance method, on a data set concerning booking centres in the Swedish taxi market, shortcomings in these methods were identified. This motivates the development of a new method. This new method, the sphere measure, enables an inefficient unit to identify existing and efficient units that have the largest similarity with itself. The identified units will thus be firm-relevant reference units.

This paper focuses on the effect of import protection on the response of the real exchange rate to capital flows. The central hypothesis is that barriers to imports blunt the expenditure and production shifting effects of changes in relative prices, and hence the ability of the real exchange rate to equilibrate the economy in response to international capital flows. Employing a cross-section approach, the study focuses on three broadly similar countries but with very different levels of protection: Argentina, Australia, and Canada. The empirical results are consistent with the central hypothesis.

Was there Monetary Autonomy in Europe on the eve of EMU? The German Dominance Hypothesis Re-Examined (pp. 185-207)

In this paper we re-examine the German dominance hypothesis, as a way to assess whether the loss of monetary autonomy in Europe associated with EMU had been significant. We use Granger-causality tests between the interest rates of Germany and all the countries participating in the European Monetary System, with the sample period running until December 1998. Our results would support a weak version of the hypothesis, with Germany playing a certain "leadership" or special role in the EMS, although she would not have been strictly the "dominant" player.

The Impact of Income and Family Structure on Delinquency (pp. 209-232)

There is no more important issue in the economics of the family than the impact of parents on the behavior of their children. By providing rewards and imposing constraints, parents seek to affect their childrenÂ’s behavior. The explanation of these actions is that the childÂ’s conduct directly enters into the parentÂ’s utility function. In this paper, we use that framework to explore the role of parental control over his or her childÂ’s delinquent behavior. Using data from the National Longitudinal Survey of Youth, we estimate the impact of family income and various dimensions of family structure on a youthÂ’s contact with the criminal justice system between the ages of 14 and 22. From this analysis, we conclude that the single most important factor affecting these measures of delinquency is the presence of his father in the home. All other factors, including family income, are much less important.

Superstores and Labour Demand: Evidence from Great Britain (pp. 233-252)

The objective of this paper is to quantify the net effect that the massive opening of edge or out-of-town superstores, which took place in Great Britain in the mid-eighties and early nineties, had on local employment. Our data set consists of the location and the opening dates of Tesco and SainsburyÂ’s stores, in combination with Census of Employment data from 1984 to 1991. Using both a fixed-effects specification and a system-GMM specification which allows to control for endogeneity, we find that in spite of the adverse effects they had on competing smaller stores, superstores had an overall positive net effect on employment.

Robert HoffmannThe University of NottinghamLee Chew GingThe University of NottinghamBala RamasamyThe University of Nottingham

The Socio-Economic Determinants of International Soccer Performance (pp. 253-272)

This paper reports regression results identifying the variables influencing a countryÂ’s performance in international soccer games. The results reveal that economic, demographic, cultural and climatic factors are important. In particular, inverted U-shape relationships are identified with respect to temperature and per-capita wealth. We also find a significant interaction between Latin cultural origin and population size, while both variables are individually insignificant. Explanations for our results are offered.

This paper studies the daily stock price reaction to new information of portfolios grouped by size quintiles. To that end, cross-correlations, autocorrelations and Dimson beta regressions are analyzed. Based on a sample of shares traded in the Santiago de Chile Stock Exchange for the 1991-1998 period, results show that larger company stock prices Â–as measured by market capitalizationÂ– react to both good and bad news sooner than the smaller ones do. Thus a crossed effect appears, although not as a cascade: only the prices of large firms react earlier than the rest. These effects do not seem to be caused by non-trading. There also are significant asymmetric lagged and cross-effects. Good news has a more pronounced lagged effect than bad news does.

This paper studies firmsÂ’ incentives to invest in environmental R&D under different market structures (Cournot and Bertrand) and environmental policy instruments (emission standards, taxes, tradable permits and auctioned permits). Because of market strategic effects, R&D incentives vary widely across market structures and instruments. For example, when firmsÂ’ products are strategic substitutes (i.e., Cournot), either emission standards, taxes or auctioned permits can provide the most incentives. But when firmsÂ’ products are strategic complements, either taxes or auctioned permits provide the most incentives. If markets are perfectly competitive, however, permits and emission standards offer similar incentives that are lower than those offered by taxes.

Country Risk and the Mundell-Fleming Model Applied to the 1999-2000 Argentine Experience (pp. 327-348)

In this paper we propose a modification of the traditional Mundell-Fleming model. The extended model introduces the implications of including the fiscal deficit and international reserves as determinants of the level of country risk. This slight modification of the traditional paradigm leads to radical changes in the effects that fiscal and monetary policies have in economies with high capital mobility under an extreme version of a fixed exchange rate regime (Currency Board). We use the proposed model to evaluate some of the economic policies implemented between December 1999 and March 2001 by the first economic team under the Presidency of Fernando De la RÃºa in Argentina. Additionally, we suggest that some of the main results obtained from the model are applicable to other emerging economies.

Allan DrazenTel Aviv University, University of Maryland, NBER, and CEPR

Central Bank Independence, Democracy, and Dollarization (pp. 1-17)

Is there a fundamental conflict between insulating monetary policy from popular pressures, seen as essential to sound monetary policy, and making policy responsive to the popular will, seen as fundamental to democracy? We argue that strongly independent monetary policy is not inconsistent with democratic control of policymaking, once one realizes that a key feature of democratic policymaking is the decision to remove some decisions from Â“day-to-dayÂ” political pressures. This is the essence of "constitutionalism," central to the functioning of democracy, by which certain decisions are made difficult to reverse. It is further argued that a conflict between popular sovereignty and policymaker independence is not unique to monetary policy, but actually characterizes most policymaking in a democracy, with institutions designed to insulate policymaking from popular pressures. A constitutional perspective implies that extreme forms of commitment, such as a dollarization, are similarly consistent with democracy. One argument for such constraints on monetary policy (as opposed to fiscal policy, for example) is agreement on what good monetary policy means.

Luis CatÃ£oIMF Research DepartmentElisabetta FalcettiEuropean Bank of Reconstruction and Development

Determinants of ArgentinaÂ’s External Trade (pp. 19-57)

Following the liberalization reforms of the late 80s and early 90s, several emerging market economies have experienced large and persistent trade deficits. This paper focuses on the Argentine experience, examining the extent to which trade imbalances in the 1990s resulted from income and relative price movements, as well as from shifts in foreign trade elasticities associated with structural changes. New estimates of export and import equations are presented using a broader set of variables than previous studies and distinguishing between intra and extra MERCOSUR trade. We find that considerable export sensitivity to world commodity prices, domestic absorption, and economic activity in Brazil, combined with a high income elasticity of imports, are key determinants of ArgentinaÂ’s trade balance.

This paper investigates the monetary interdependence and the money-income relationship between countries under a pegged and a floating exchange rate system during the same time period (1979-1997). The relationship is tested between three ERM countries, France, Germany and Holland, and also between these countries and the United States. The ERM countries have a pegged exchange rate between themselves, and the rate between these countries and the United States is freely floating. The empirical tests are conducted by means of the Johansen multivariate cointegration method and the error correction model. Among the ERM countries, international transmission of monetary policy is found in almost all directions. This may provide evidence against the theory of German domination of the EMU. In the second set of tests, the United States money is found to affect all three European incomes but not vice versa.

Are the Poor Protected from Budget Cuts? Evidence for Argentina (pp. 95-121)

Macroeconomic adjustment programs often emphasize the need to protect social spending from cuts, and to protect pro-poor spending in particular. But does this happen in practice during fiscal contractions? The paper presents evidence for Argentina. Using aggregate time series data the paper first finds that social spending was not protected historically, although more "pro-poor" social spending was no more vulnerable. Turning next to new data for an externally-financed workfare scheme introduced in response to a macro crisis, the paper finds that this program was far better targeted than other social spending. However, it appears that the program still had to assure that a small but relatively well-protected share of its benefits went to the non-poor. This appears to be a political economy constraint.

We study four issues in R&DÂ–productivity dynamics: does R&D Granger cause productivity, is there a lag between R&D and its productivity effects, does the potency of R&D vary in timing and magnitude, and what is the role of R&D spillovers and aggregate shocks. The results suggest that R&D causes productivity but not vice versa, productivity responds to changes in R&D with a considerable lag, the potency of R&D varies in timing and magnitude, and that the elasticity of productivity with respect to aggregate shocks is high, but negligible with respect to R&D spillovers.

In Chile there is a public insurance system where people contribute a fixed percentage of their income, and also a private system where people pay a premium based on their personal characteristics. Using a large survey for 1996, we study the determinants of the decision to buy a private health plan. We find that the probability of buying a private health plan is positively correlated with income and living in areas with private health services providers. This probability decreases as families become older, and with a larger proportion of fertile age females. We also find that people who are more likely to demand health services prefer to buy a private health plan, and that people enrolled in a private health plan increase their use of health services. The segmentation observed in the health sector relates with the way private insurers and the public insurance system set their premiums.

The failure of the structural monetary model to beat a random walk in out-of-sample forecasting is one of the most celebrated empirical (non) findings in international finance. In this paper we show that this result is an artifact of the way monetary policy is measured. We construct a simple measure of monetary policy based on the narrative approach of Romer & Romer (1989). Using a linear Gaussian autoregressive specification with exogenous variables (ARX), we demonstrate that a structural monetary model with properly measured money does indeed outperform the random walk in out-of-sample forecasts over a wide range of horizons. We conclude that contrary to the conventional wisdom, money (appropriately defined) is a robust fundamental determinant of short-run exchange rate dynamics.

INSTITUTIONS, CONTRACTS AND REGULATION OF INFRASTRUCTURE IN ARGENTINA (pp. 217-254)

Massive privatization in the Argentine infrastructure and public service sectors gave an opportunity to explore why we observe notorious differences in regulatory design choices and performance outcomes across sectors, under the umbrella of similar nation-specific institutional characteristics -same federal government producing reform during a short period of time (1990-95)-. Following the Levy and Spiller (1996) conceptual framework, we propose that some institutional characteristics (namely the nature of conflicts among groups affected by reform and administrative capabilities) determined a wide variety of government choices for regulatory incentives, producing different outcomes across sectors. Despite the will of the executive power to respect stable "rules of the game", episodes of government opportunism appeared in most sectors. Poor regulatory incentive design and weak agencies, on the other hand, prompted ex-post opportunistic behavior from regulated firms, which renegotiated contractual conditions to their favor.

WHO GETS THE JOB AND WHY? AN EXPLORATIVE STUDY OF EMPLOYERSÂ’ RECRUITMENT BEHAVIOR (pp. 255-278)

In the literature of labor economics we find many examples of studies analyzing job seekers search behavior, but few examples of the corresponding analysis of the recruitment behavior of employers. This paper gives a picture of the recruitment behavior of Swedish employers. The analysis is based on about 800 telephone interviews with employers regarding the last person they had hired. This paper relates the lemonÂ’s problem in Akerlof with the Spence signaling model, and then it proceeds to relate indices and signals to the hiring behavior of employers. Employers mainly recruit personnel in order to expand a certain activity of their firm. On an average the total recruitment process takes about a month. In first round employers mainly look for job seekers with good education and experience. During the job interview the employer search for persons with professional knowledge, personal engagement and social competence.

ON NON-LINEARITIES BETWEEN EXPORTS OF MANUFACTURES AND ECONOMIC GROWTH (pp. 279-311)

Building up human capital and other complementarities may be important in the link between exports of manufactures and economic growth. On the other hand, managerial strategies that push for export promotion may be important, too. Though both may yield non-linearities in the link between exports and growth, the associated patterns differ. In this paper we take an aseptic, empirical view in the link between these two variables and the possible non-linear links. Since direct testing for non-linearities in panel data may yield non-significant results although they may actually be present, we propose a very simple method that may serve as a first approximation to uncover such non-linearities. We also take into consideration endogeneity and reverse causality problems (Arellano and Bover, 1995), and definitional problems in our variable of interest. In fact, we use a panel of 96 countries for the period 1960-1995 and find evidence consistent with the presence of non-linearities. We apply formal sensitivity analysis and confirm the results.

It is shown that the volume of trade can be decomposed into proportional proxies for stochastic flows of good news and bad news into the market. Positive (good) information flows are assumed to increase the price of a financial vehicle while negative (bad) information flows decrease the price. For the majority of a sample of ten split-stocks it is shown that the proposed decomposition explains more GARCH than volume itself. Using the proposed decomposition, the variance of returns for younger split stocks reacts asymmetrically to good news flowing into the market, while the variance for older split-stocks reacts symmetrically to good news and bad news.

SIZE OF THE MILITARY SECTOR AND ECONOMIC GROWTH: A PANEL DATA ANALYSIS OF AFRICA AND LATIN AMERICA (pp. 329-360)

We estimate the influence of defense spending and military labor use on economic growth in African and Latin American countries. Our model integrates disparate implications from the defense economics literature into a Barro-style model of economic growth that controls for political and economic institutional variation across countries. Our panel data analysis of 44 countries in Africa and Latin America from 1975 to 1989 also controls for cross-country variation in lost human capital and public sector production inefficiencies. We find empirical evidence that the defense burden on economic growth is non-linear, with low levels of military spending increasing economic growth but higher levels of military spending decreasing growth. We also find evidence that the influence of military labor use on growth is non-linear, and exhibits a greater drag on economic growth in those countries with relatively higher levels of adult male education attainment.

An Examination of the Statistical Discrepancy and Private Investment Expenditure (pp. 27-61)

The statistical discrepancy is often used to gauge the reliability of national accounts data. Particularly since the mid-1980Â’s the statistical discrepancy in Australia has grown significantly in size and variance. In this paper we demonstrate that the overwhelming contribution to the size of the statistical discrepancy is mismeasurement of private investment expenditure. We demonstrate that this mismeasurement not only adds to the volatility of investment but may have a significant impact on the volatility of the business cycle in general.

Efficiency in European railways: Not as inefficient as one might think (pp. 63-88)

The paper studies technical inefficiency in the railway systems of ten countries of the European Union. A new approach is used which permits the disaggregation of inefficiency by factor of production to result in estimates of input-specific technical inefficiency. The cost structure is represented using a generalized McFadden flexible functional form. Policy implications and guidelines for rational decision making in the railway sector, are discussed in detail.

Does High Inflation Affect Growth in the Long and Short Run? (pp. 89-105)

This paper investigates the relationship between inflation and output in the context of an economy facing persistent high inflation. By analyzing the case of Brazil, we find that inflation does not impact real output in the long run, but that in the short run there exists a negative effect from inflation on output. These results support SidrauskiÂ’s (1967) superneutrality of money in the long run, but cast doubt on the short run implications of the model for separable utility functions in consumption and real money balances, as exposed by Fischer (1979). The results are more likely to support a class of utility functions in which real money balances and consumption are perfect complements.

Maintenance and production interact. The ideal way of accounting for this interaction, when estimating production functions, is by picking the temporal length of observations so that they embed integer multiples of the productionÂ—maintenance cycles for all inputs. In contrast to labor and land, the productionÂ—maintenance cycles of capital sometimes vary tremendously in temporal length, which can make it impossible to implement the ideal method of accounting for the interaction between maintenance and production. This paper empirically tests four second best methods of accounting for maintenance, when the ideal method is impossible. The output elasticities of all inputs (not just the input undergoing maintenance), which emerge from these tests, vary tremendously. This implies that the way that maintenance is incorporated into the analysis (including the standard approach of ignoring maintenance) drastically affects the profit maximizing combinations of inputs derived from production function estimations.

The opening of the capital account was one of the important structural reforms implemented by Argentina. This liberalization increased the linkage of the real economy with the changing conditions of the international financial markets. In particular, recent data show a clear relation between interest rates and the business cycle on the one hand, and sovereign spreads on the other. In order to understand better these linkages, it is necessary to analyze the determinants of these spreads also known as country risk. Using monthly data for the period 1994 to 1998, we find that this spread is explained by: 1) growth expectations, 2) fiscal deficits, 3) the debt service to export ratio and its growth rate, 4) contagion effects, 5) external shocks including movements of international interest rates, and 6) political noise. Based on these findings, we offer a discussion of some of the policies that should be implemented in order for the spreads to start declining and for the country to eventually reach an "investment grade" rating for its sovereign bonds.

Technical Efficiency, Allocative Efficiency, and the Implementation of a Price Cap Plan in Telecommunications in the United States (pp. 163-186)

Incentive regulation is designed to improve productive efficiency, enhance service quality and consumer welfare, and reduce the costs of regulation. The issue that is considered here is whether incentive regulation in the form of a price cap applicable to interstate access service to local loops in the telecommunications industry in the United States has resulted in an increase in the technical efficiency and allocative efficiency of local exchange carriers. The results suggest that for changes in technical efficiency, there is a definite randomness between 1985 and 1993 with technical efficiency increasing in some years and decreasing in others. Subsequent to 1993, however, there is a consistent improvement in technical efficiency. Given that incentive regulation in the form of price caps was implemented in 1991, it is likely that some portion of the improvement in technical efficiency subsequent to 1993 is attributable to incentive regulation.

Hodrick-Prescott filter has been the favourite empirical technique among researchers studying "cycles". Software facilities and the optimality criterion, from which the filter can be derived, can explain its wide use. However, different shortcomings and drawbacks have been pointed out in the literature, as alteration of variability and persistence and detecting spurious cycles and correlations. This paper discusses these criticisms from an empirical point of view trying to clarify what the filter can and cannot do. In particular, a less mechanical use for descriptive analysis is proposed: testing how the estimated cyclical component behaves and using autocorrelation adjusted standard errors to evaluate cross correlations to differentiate the "genuine" from "spurious" case. Simulation results to test these bivariate correlations when there is a "genuine" relationship are presented. Some examples of descriptive analysis for macro aggregates (real activity, trade flows and money) of Argentina and USA are reported to show that not always the filter is appropriate. Simple tools are used to appreciate how the filtered series result and to evaluate cross correlations.

We examine the implications of high degrees of dollarization for the choice of exchange rate regime and the information content of various monetary aggregates in developing countries. We conclude that a high degree of currency substitution argues for a more fixed exchange rate regime, while asset substitution may imply that either more rigid or more flexible regimes may be appropriate. We also ask whether the most informative monetary aggregates include dollar assets. Based on an analysis of five countries, we conclude inter alia that broader aggregates that include dollar assets perform better than those that do not.

Water Management in France: Delegation and Irreversibility (pp. 325-352)

The problem that we address in this paper stems from the trend to delegation in the water management field. It refers to the municipalityÂ’s negotiating disadvantage in the face of cartelized water management firms that makes delegation, once undertaken, virtually irreversible. We show why the characteristics of the delegation auction render is useless as a tool for collective welfare maximization. We also show that the remaining tool for achieving collective welfare maximization, i.e. the municipalityÂ’s right to revoke delegation and return to direct management, is also ineffective due to a lack of credibility that is essentially financial in nature. Thus, if the credibility of revocation could be restored, the municipalityÂ’s bargaining power could also be restored. Using standard methods of stochastic calculus, we model the municipalityÂ’s right of revocation as a call option held by the municipality. We show that the key variable for the value of this option, and thus for the municipalityÂ’s position, is the exercise price, which is partly determined by objective economic criteria and partly by legal and institutional conventions. We show that community welfare maximisation occurs at the point where the exercise price is determined exclusively by objective economic criteria. Since the delegated firm as a simple agent has the right to abrogate the contract if delegation becomes unprofitable, we then model this right as a put option held by the firm. Its value also depends to a large extent on the exercise price, which is partly determined by objective economic criteria and partly by legal and institutional conventions. Combining the exercise points of the two options enables us to determine the price-profit interval over which delegation will be acceptable to both parties. We conclude that the optimal interval will be the one where the exercise prices are determined entirely by objective economic criteria.

Does Gender and Birth Order Matter when Parents Specialize in ChildÂ’s Nutrition? Evidence from Chile (pp. 353-386)

Using household survey data from Chile the current paper presents evidence of how the nutritional status of the child reflects differences in parental preferences and child rearing technology within an intra-household allocation approach that includes a health production function. From the household optimization problem we estimate the nutritional status of the child conditional on a set of child, family and community covariates that reflect parental preferences and parental child rearing technology. We test directly whether birth-order in the family and whether being a son or being a daughter reflect how parents allocate the resources, given that the Chilean family is often linked to a machismo sentiment in the division of household chores. Logit estimates of the nutritional status of the child show gender specialization on child rearing: mothers give more resources to their daughters and fathers to their sons. This gender polarity is significant for non-oldest daughters and non-oldest sons, reflecting perhaps infant-order experience in child-care specialization. We also find that fatherÂ’s education is less important than motherÂ’s education. Nevertheless, mothers with higher education levels than their spouse seem to assign less family resources to their children than those who are relatively less educated.

This paper investigates the effect of market segmentation on stock prices and returns in emerging Chinese markets. Under the assumption of infinite investment horizon and representative consumer, I formulate an Intertemporal Capital Asset Pricing Model (ICAPM) with restrictions on share ownership. The model posits that cross-section variations in the average excess returns between domestic A -and foreign B- shares depend on systematic risks as measured by shares' own market betas and betas with respect to the international equity markets. After correcting for errors-in-variable problem, I obtain econometric results consistent with the empirical predictions of ICAPM.

This paper presents a theory that explains the prevalence of different models of privatization across countries and across industries. First, it establishes the analytical framework for determining the impact of privatization on the value of a privatized firm, on aggregate social welfare, and on the relevant interest groups: taxpayers, consumers, employees, and private investors. Merging both the income distribution and the production efficiency aspects of the process, it identifies the government's principal decision variables, and presents the political tradeoffs faced by the government when carrying out privatization. Based on this framework, the paper offers an outline for testing the hypothesis that privatization introduces a Pareto-dominating mode of operation. Two fundamental laws of privatization define necessary and sufficient conditions for Pareto-dominance. Based on four economically sensible principal assumptions, the paper analyzes the government's behavior under alternative objective functions: maximization of taxpayer welfare, maximization of aggregate social welfare, and maximization of political support. The main result reveals that a vote-maximizing government sets the optimal value of its decision variables, depending on the characteristics of the political market. This result is illustrated through a cross-country and a cross-industry comparison.

The Applicability of the Sectoral Shift Hypothesis in the Netherlands (pp. 57-69)

The sectoral shift hypothesis in the Netherlands cannot be easily tested for the presence of rigorous structural breaks in the data. Therefore, a Kalman Filter approach is adopted. What we find, is that the variables capturing the sectoral shift hypothesis are the most important in explaining Dutch unemployment behavior during the postwar period. This means that cyclical unemployment in the Netherlands can be viewed as a fluctuation of the natural rate of unemployment.

The freedom and growth literature has consistently shown that nations which have fewer restrictions on private agents and transactions tend to higher levels of economic growth. It is less clear, however, whether freedom causes growth, growth causes freedom, or the two are jointly determined. To assess these possibilities, Granger-causality tests are performed on annual freedom indicators developed by the Heritage Foundation and national growth rates. The underlying component indexes, which include Trade Policy, Taxation, Government Intervention, Monetary Policy, Capital Flows and Foreign Investment, Banking, Wage and Price Controls, Property Rights, Regulation, and Black Markets, are also tested in addition to the summary freedom rating. The tests suggest the average level of freedom in a nation, as well as many of the specific underlying components of freedom, precedes growth. However, growth may precede one of the component indexes (Government Intervention), and no relationship is found to exist between growth and two of the indexes (Trade Policy and Taxation).

This work assesses the changes in aggregate poverty and inequality that have taken place in Latin America during the past 26 years. With this objective, we put together the largest number of observations on income distribution for the region for the period from 1970-1995. We find that poverty and inequality have not declined during the 1990s in spite of improvements at the macroeconomic level. The characteristics of our data allow us to perform various comparisons between countries. Our results show that even though there are differences in levels across countries, inequality and poverty in most of them follow similar trends during the period under study.

Alberto PortoNational University of La PlataNatalia PortoNational University of La Plata

Fiscal Decentralization and Voters' Choices as Control (pp. 135-167)

This paper investigates, empirically, the voters` choices as a mechanism of control of the municipal governments in Argentina. In particular, the paper explores the question of whether voters choose to support the political party in office based on its fiscal performance while in office. After a learning period, citizens vote considering the fiscal performance. The smaller the jurisdiction, the more sensitive the citizens. Voters, in evaluating fiscal performance to take voting decisions, consider the performance in the recent past. Municipal elections are not a mere rehearsal of national or provincial elections. We conclude that we can trust in fiscal decentralization and voting. Perhaps, it is a better option than fiscal centralization.

This paper focuses on several topics related to macroeconomic policies in LDC's. The selection is biased towards those cases I have dealt with during my last 20 years of professional experience, home based in Argentina. Inflation, dollarization, quasi-fiscal deficits, capital controls and stabilization policies are old friends of Latin-Americans. Currency Boards, Common Markets, Lender of Last Resort and Country Risk are newer concepts that have taken special relevance in the 90's, the decade of globalization.

This paper provides a political economy explanation for temporary exchange-rate-based stabilization programs (where the exchange rate is used as a nominal anchor) and their optimal duration by focusing on the distributive effects of real exchange rate appreciation. In a small-open-economy model, a temporary reduction in the devaluation rate leads to a reduction in the nominal interest rate and to a temporary appreciation of the real exchange rate. Owners of tradable-goods are hurt, while for reasonable parameter values, the owners of non-traded goods' welfare improves.

The Cash Flow Model with Float: A New Approach to Deal with Valuation and Agency Problems. (pp. 247-279)

In this paper we introduce a cash flow model with float to manage core issues in Corporate Finance. The float actually removes current hindrances pervading the standard cash flow model. To start with, we derive the float model and uncover its underlying financial engineering. After that, any investment decision is regarded as a synthetic portfolio made out of a revenue bond financing the investment, and a performance swap acting as a value driver. It is within the performance swap where the float lies and enhances value. Furthermore, extension to valuation is provided taking advantage of the former portfolio approach. Next, the float complex structure is displayed to proceed towards its sources and uses of cash flows. Last of all, we expand upon a normative model which makes the most of the float and spells out how an accountability precept should be functional in redressing agency problems.

Cyclicality and Durability: Evidence from U.S. Consumers' Expediture. (pp. 299-310)

In this paper three hypotheses concerning the cyclicality of U.S. consumers' expenditure are proposed. These hypotheses are based upon the distinction between expenditure on durable and non-durable goods. It is argued that durability will lead to increased cyclical sensitivity and that this increased cyclicality will be of an asymmetric nature. The asymmetric adjustment will be of the form of decreases in expenditure on durable goods being more extensive and more rapid during recessionary phases of the business cycle than corresponding increases during expansionary periods. These hypotheses are evaluated using U.S. data on consumer durables and non-durables over the period 1959-1998. Via the use of the Hodrick-Prescott (1997) filter the cyclical elements of these series are derived and subjected to Sichel's (1993) univariate tests of business cycle asymmetry. Overwhelming support is found for all of the hypotheses proposed.

Transaction Costs and Overinsurance in Government Transfer Policy. (pp. 311-335)

Benevolent governments lacking commitment ability provide too much insurance, if opportunistic private agents free ride on the governmentÂ´s concern and exert too little effort expecting government assistance. Yet, the costs of implementing the transfer policy work as a commitment device, alleviating the credibility problem. Indeed, despite of the lack of commitment capacity, the government might provide incomplete insurance because of these transaction costs. Therefore, transaction costs can increase welfare by resolving the dynamic inconsistency faced by a welfare maximizing policymaker.

This paper investigates whether there is any relationship between farm size, technical efficiency and the use of agrochemicals which are potentially environmentally contaminating. These questions are pertinent in the context of current EU policy decisions. Using two models of stochastic frontier production and a set of panel data on 35 farms from the South West of England for the years 1987-1991, we obtain an indication, that there is a positive relationship between technical efficiency and use of contaminants, and between technical efficiency and farm size. However, there is a weak negative relationship between farm size and use of contaminants.

Fiscal Decentralization and Government Size in Latin America (pp. 357-391)

This paper explores the link between fiscal decentralization and government size in Latin America. While most related work attempts to test Brennan and Buchanan's "Liviathan" hypothesis, here the emphasis is placed on a different channel: the potential for decentralization to aggravate the common pool problem. In addition to the degree of expenditure decentralization, we consider the importance of vertical fiscal imbalance, as well as some institutional variables related to the nature of intergovernmental relations which can affect the ability of some jurisdictions to shift the cost of their local programs onto others: the degree to which intergovernmental transfers are discretional, and the degree to which subnational governments have borrowing autonomy. We find that decentralization tends to produce larger governments, but this effect is particularly important in cases where vertical imbalance is high, transfers are discretional and the degree of borrowing autonomy of subnational governments is large.

Product Differentiation and Market Power in the California Gasoline Market (pp. 1-27)

This paper applies a model of market power measurement under product differentiation to the case of the gasoline market in California, using data for the period 1983-1989. Our results show that there is a considerable degree of product differentiation among major brands. This allows firms to exercise local market power over their own specific products, but there are also signals of an important degree of global market power. However, none of the four pure market structures analyzed (price taking, monopolistic competition, Cournot oligopoly and collusion) seems able to explain by itself the behavior of the whole market.

Trade and Trade Reform in Latin America and the Caribbean in the 1990s (pp. 61-96)

For many decades, trade policy in Latin America and the Caribbean (LAC) had involved very high levels of protection and of government intervention. The active pursuit of import substitution policies reduced the openness and efficiency of the regions economies. It also increased their external vulnerability, as they became dependent on a narrow range of export products, with little ability to absorb external shocks. This state of affairs changed markedly in the 1980s and 1990s, when most countries of the region moved to liberalize their trade regime. Trade policy reform in LAC in the 1990s has been both widespread and extensive, and the region now shows a fairly open trade regime. Such a sharp policy reversal clearly had an impact on trade flows, and those effectively underwent significant changes in the past decade. They also coincided with a number of other important changes in the LAC economies, including major structural reforms (with the privatization of many public enterprises and the deregulation of most domestic markets), a surge in investment (itself partly linked to the lower relative prices for capital goods resulting from higher openness), higher capital flows, and a more careful pursuit of macroeconomic policy aimed at preserving financial stability to foster sustainable growth. This paper seeks to assess the magnitude of the changes in trade flows in the past decade in the context of changes in the underlying policy framework. Section I summarizes the main trends observed in LAC trade over the 1990-97 period. Section II summarizes trade liberalization in the region since the mid-1980s. Section III attempts to assess how trade liberalization has affected the volume and structure of trade flows. Section IV concludes with some policy recommendations in the area of trade, particularly in the context of the present global financial crisis.

We propose a new procedure to rank portfolio performance. Given a set of N portfolios, we use statistical tests of dominance which produce direct mean-variance comparisons between any two portfolios in the set. These tests yield an NxN matrix of pairwise comparisons. A ranking function maps the elements of the comparison matrix into a numerical ranking. To illustrate the procedure we use a set of 133 mutual funds, including the S&P500 index and the CRSP equal and value weighted indexes. We explore the empirical and theoretical relationships between our ranking procedure and the Treynor, Sharpe and Jensen performance measures. In general, the new procedure?s ranking is relatively robust, does not allow for gaming and can be performed with small samples.

Understanding the "Problem of Economic Development": The Role of Factor Mobility and International Taxation (pp. 131-167)

The problem of economic development, as Lucas (1988) states it, is the problem of accounting for the observed diversity in levels and rates of growth of per capita income across countries and across time. We study conditions under which capital mobility and labor mobility (two seemingly income-equalizing forces) may interact with cross-country differences in income tax rates and income tax principles (two seemingly income-diverging forces) to generate such diversity. As a corollary, we also examine when countries with different initial endowments may finally converge in their income levels.

A long-standing concern in political economy is whether outcomes are efficient in political equilibrium. Recent contributions have examined the efficiency/inefficiency of policy choices from a theoretical point of view. The aim of this paper is to examine such issue empirically. Building on existing "economic" diagnoses that highlight the deficient incentives present in ArgentinaÂ’s Federal Tax-Sharing Agreement the paper will attempt to understand the politics behind its adoption and persistence. We suggest an explanation based on the transaction costs of ArgentinaÂ’s political market. Although potentially Pareto-improving policies could have been adopted, they were not introduced because of the uncertainty over the future status of todayÂ’s bargains, and given the lack of institutions to enforce bargains among the political actors. The paper concludes offering some preliminary ideas for institutional engineering: what governance structures could help reduce these transaction costs? The purpose is to create an institutional framework in which political actors could negotiate among themselves, ensuring the enforceability of agreements, in order to achieve more efficient outcomes.

A Methodological Investigation of Cost of Carbon Sequestration (pp. 231-277)

Increased attention by policy makers to the threat of global climate change has brought with it considerable attention to the possibility of encouraging the growth of forests as a means of sequestering carbon dioxide. This approach has, in fact, become an explicit element of both U.S. and international climate policies. This paper develops a methodology whereby estimates of the costs of carbon sequestration can be developed on the basis of evidence from observations of landowners' behavior when confronted with the opportunity costs of alternative land uses. The analytical model takes account of silvicultural understanding of the intertemporal linkages between deforestation and carbon emissions, on the one hand and between forestation and carbon sequestration, on the other. The results support the efficacy and potential value of this analytical approach. The paper is intended to be illustrative of how econometric analyses of land use, which already exist for a number of countries, can be used to develop better region-specific estimates of the marginal costs of carbon sequestration.

This paper uses analytically tractable and numerically solved general equilibrium models to examine the significance of pre-existing distortions in factor markets for revenue-neutral environmental tax reforms and for various policies involving pollution quotas and permits. Results indicate that pre-existing factor taxes generally raise the costs of these environmental policies. This reflects a tax-interaction effect: the lowering of real factor returns resulting from the higher output prices occasioned by environmental taxes and other regulations. The revenue-recycling effect - stemming from the use of environmental tax revenues to finance cuts in pre-existing factor taxes - helps reduce policy costs, but under plausible assumptions does not eliminate the costs of such policies: the double dividend does not materialize. Even if it does not produce a double dividend, the revenue-recycling effect is important for reducing policy costs. Policies that fail to exploit the revenue-recycling effect suffer significant disadvantages in terms of efficiency. Like environmental taxes, freely allocated (or grandfathered) pollution quotas or permits, for example, produce a costly tax-interaction effect, yet such quotas or permits do not enjoy the offsetting revenue-recycling effect. Auctioning the permits or quotas makes possible the revenue-recycling effect and allows given pollution-abatement targets to be achieved at lower cost. The failure to exploit the revenue-recycling effect can alter the sign of overall efficiency impact. Indeed, if marginal environmental benefits from pollution reductions are below a certain threshold value, then any level of pollution abatement through freely allocated quotas or permits is efficiency-reducing. The tax-interaction effect is relevant to government regulation outside the environmental area. To the extent that regulations on international trade or agricultural production raise output prices and thereby reduce real factor returns, these regulations exacerbate the factor-market distortions from pre-existing taxes and thus involve higher social costs than would be indicated by partial equilibrium analyses.

In December 1997, 34 industrialized countries signed the Kyoto Protocol committing to targets and timetables to reduce 6 greenhouse gases (GHGs). Why were the only signatories industrialized countries? Two reasons are usually put forth. The first is pragmatism, in that only this group, as opposed to developing countries, can afford the costs of mitigating GHGs. Still, this explanation is imperfect since 12 of the signatories are transitional economies of Eastern Europe and the former Soviet Union. The second reason is fairness, in that industrialized countries are responsible for the vast majority of the GHGs already built-up in the atmosphere and are responsible for over 60% of the current emissions. The fairness explanation is further supported by the fact that "differentiation" was invoked in Kyoto, i.e., not all signatories agreed to equal cutbacks, several citing special economic circumstances. In the future, both pragmatism and fairness will be relevant to the question of when and how developing countries will sign a global GHG agreement. Another major influence will be the pursuit of economic efficiency or, at least, cost-effectiveness, i.e., making sure that the targets are met at the lowest global cost. This can be fine-tuned in future agreements by the use of incentive-based instruments and the timing of commitments. Efficiency may also be affected by relative burden-sharing, since this will influence the number of countries that make mitigation commitments in the future. The purpose of this paper is to analyze fairness, or equity, aspects of the current Kyoto Protocol and its extension to a truly global agreement that includes developing countries. This is done in the context of a policy approach gaining increasing favor - tradeable emission permits. A dynamic model of intercountry CO2 permit trading is used to address the following questions: 1) To what extent does permit trading lower global CO2 mitigation costs? 2) How are intercountry welfare impacts influenced by alternative permit distributions according to various equity criteria? 3) How might developing countries be brought into the agreement without requiring CO2 reductions, yet promoting global efficiency gains by utilizing their relatively lower cost mitigation capabilities? 4) To what extent does allowing for permit trading over time further lower global mitigation costs? 5) How are intercountry welfare impacts distinguished by not just static definitions of equity but also dynamic versions, such as sustainability criteria?

The paper studies the design of a treadable permit system with opt-in possibilities for LDCs countries in the context of climate change. In setting the optimal opt-in rule, the regulator faces a trade-off between production efficiency (minimization of control costs) and information rent extraction (reduction of excess permits). Results from simulation exercises based on data from MITÂ´s EPPA Model are also provided.

Locally motivated air quality programs in Santiago and Mexico City have only minor collateral benefits for the global climate. If agencies with global and local agendas did business together, then individuals and firms and even cities would act globally when thinking locally, and one would see greater synergy. Eskeland and Xie find that locally motivated air quality programs for urban transport have limited collateral benefits in terms of protecting the global climate. This could puzzle some, since these two public goods one global, one local seem to be jointly produced. However, air quality in Mexico City, Santiago, and elsewhere is predominantly pursued by technical improvements (making cars and fuels cleaner), and not by reducing demand for polluting goods and services (though in Europe high fuel taxes help reduce demand). Control programs developed under joint stimulus to protect the global and local environment have not yet been seen, and they may surprise us when they come. However, they will likely rely more on reducing demand, using instruments such as corrective (Pigovian) taxes on fuels. The authors show how, if locally and globally charged agencies can do business together, consumers, producers, and cities will act globally when thinking locally. Only then will we know the extent to which local and global benefits are produced jointly.

This research uses neighborhood characteristics (at the zipcode level) in 1990 to explain toxic releases in 1993. It combines the Toxics Release Inventory data with demographic data from the 1990 US Census. We first analyze the location of manufacturing facilities in a particular neighborhood using a sample selection model, and then estimate the relationship between releases in 1993 and the demographic characteristics of the neighborhood in 1990. We conduct the analysis for the entire US as well as for different geographic regions to study regional differences in determinants of environmental outcomes. Releases in non-urban areas of the southeastern US exhibit a pattern suggesting that race might be an important determinant of release patterns. Economic characteristics of neighborhoods (such as income levels and unemployment) also affect releases. Our variables that proxy the propensity for communities to engage in political action exert greater influence on environmental outcomes in non-urban areas.

This paper has the purpose of transmitting to the younger generation of economists some insights and judgments that seem to have been bypassed or overlooked as the literature of the economics profession has evolved. In the main, the paper tries to explain what is "The right place" within economics to employ particular sets of assumptions or methods. Where is the use of the representative consumer appropriate, and where not? What is the "natural" range of application for overlapping generation models? When is it appropriate to treat the capital flow to (or from) a country as infinitely elastic with respect to the interest rate? These and other questions will be pursued, with the objective of alerting the younger generations to important decisions they have to make as they strive to keep economic science robust, relevant and helpful in improving the economic life of real-world populations.

The paper studies mechanisms through which a sudden stop in international credit flows may bring about financial and balance of payments crises. It is shown that these crises can occur even though the current account deficit is fully financed by foreign direct investment. However, equity and long-term bond financing may shield the economy from sudden stop crises. The paper also examines possible factors that could trigger sudden stops, and argues that the greater independence that countries have, as compared to regions of a given country, could help to explain why sudden stop crises are more prevalent and destructive at international than at national levels.

Current debates on globalization have tended to focus on financial market volatility and contagion. In fact, many proponents of the imposition of some form of capital restrictions in emerging markets have argued that these would help reduce - or even eliminate -spillover across emerging market. Although this has been an old concern among developing economies, it has become more generalized after the Mexican, East Asian and Russian crises. In this paper I use high frequency data on short term nominal interest rates during the 1990s in three Latin American countries - Argentina, Chile and Mexico -- to analyze whether there has been volatility contagion from Mexico to the two South American nations. The results obtained from the estimation of augmented GARCH equations indicate, quite strongly, that while there has been volatility contagion from Mexico to Argentina, there has been no volatility contagion from Mexico to Chile. These results also indicate, however, that with the exception of a brief period in 1995, nominal interest rates have been more volatile in Chile than in Argentina. The results reported in this paper also indicate that interest rate differentials with respect to the US have tended to disappear somewhat slowly in both Chile and Argentina. Moreover, the estimation of rolling regressions for Chile indicate that after capital controls on capital inflows were imposed, interest rate differentials became more sluggish and tended to disappear more slowly than during the free capital mobility period.

Designing a Capitalist Economy for Fast Growth and High Employment in Today's Globalized World Economy (pp. 87-103)

The paper begins with a consideration of the hypothesis that public sector employment is a means to reduce the general unemployment rate. It then takes up the proposition that subsidizing domestic investment is an effective way to reduce unemployment. The rest of the paper addresses some of the questions arising about employment subsidies as a means to reduce unemployment. A crucial question is the best way to finance an employment subsidy. Is it a payroll tax? a Value Added Tax? if enforceable, some sort of tax on wealth or non-wage income? Or is the best answer a cutback in welfare entitlements - in "social wealth" - which would permit the introduction of employment subsidies without widening the budgetary deficit. The paper goes on to consider the hypothesis that, in the medium term and beyond, the best remedy is a cut of tax rates (on labor, possibly on domestic capital) financed by the same cutback in welfare entitlements.

Central Bank and Price Stability: Is a Single Objetive Enough? (pp. 105-122)

Current developments in monetary theory, coupled with the recent practical experience of many and diverse central banks, suggest a number of basic tenets that could be regarded as effective guideposts in the search for successful practices that could contribute to attain and to sustain macroeconomic stabilization. While common sense, the myriad of accompanying circumstances within which policies and institutions develop, tend to confound their significance and to blur their basic meaning and implications. The purpose of this paper is to review and revisit, in the light of prevailing experience, the state of the art regarding monetary and central banking policies and analyze, by outlining these experiences in the form of seven basic principles, their significance for the achievement and the maintenance of macroeconomic stabilization. While each of these principles can be reviewed independently, they are, of course closely linked. The paper first scrutinizes the manner in which the literature has dealt with these issues and, in light of recent experiences, attempts to integrate them into an unified framework and to draw a number of policy lessons and theoretical implications.

The main purpose of this paper is to analyze the process by which Chile was able to reduce inflation during the 1990s. In this period inflation was gradually reduced from close to 30% per annum in 1990 to only 6% in 1997. The paper concludes that three factors were important in helping to accomplish this performance. First, the independent Central Bank and its tough actions early on -to convey the message that it was ready to stand behind its mandate (to reduce inflation)- helped to shape inflationary expectations and in the process it led to lower wage inflation and ultimately a lower path for core inflation. Second, a restrictive monetary policy, and the foreign exchange intervention policies associated with it, resulted in a trajectory of the nominal exchange rate much below what would have been observed under a PPP rule adjusted for differences in productivity. This result was reinforced by the low credibility of the band reflected in the effect of the location of the exchange rate within the band on the observed rate. Third, the higher rate of growth of labor productivity, given the wage equation, resulted in a lower rate of growth of unit labor cost than otherwise. From these three effects the first effect, the enhanced credibility of the new policy operating through the formation of inflation expectations, was found to be the most important factor behind the success in reducing inflation rate.

Over the past decade, open economy macroeconomics has been broadened to encompass international lending and it has been deepened by microeconomic approaches to the role of money and the determinants of intertemporal resource allocation. The present paper offers a highly simplified model of trade in goods and money to explore the determinants of real interest rates and the price level in the world economy. The purpose of the paper is to set out the absolutely simplest model of the world economy where money and debt are held and traded so as to create foundations for the ambitious questions of welfare economics or risk that are now increasingly attracting attention.

Larry A. SjaastadUniversity of Chicago and University of Western Australia

Why PPP Real Exchange Rates Mislead (pp. 179-207)

This paper investigates the properties of the purchasing-power-parity (PPP) real exchange rate as a proxy for the true real exchange rate, which is defined as the relative price of traded goods. It finds that the PPP real exchange rate is prone to measurement error and examines the nature of that error. Measurement error is defined as the fraction of the variance of the PPP real exchange rate that has no counterpart in the true real exchange rate. That measurement error is estimated for seven small countries and the results indicate that, in most cases, the error component of PPP real exchange rates is extremely high.

As if it were still necessary, events unfolding in Asia for over a year reconfirm the critical importance of a sound, efficient financial sector for economic development and growth. Indeed, a growing number of studies underscore the risks that a vulnerable financial sector pose for macroeconomic stability. In this context, it is often argued that the liberalization of capital account heightens financial sector vulnerability. But openness to capital flows can also underpin and deepen the development of the financial sector, thus contributing to its robustness. The paper examines these issues, drawing a parallel between capital account liberalization and domestic financial deregulation, indicating the role of the macroeconomic policy environment and reviewing their implications for the pace and sequence of the external liberalization process. The examination concludes with a brief discussion of the role and procedures the IMF envisages to take toward capital account liberalization.